AP Moeller - Maersk A/S

CSE:MAERSK B

Earnings Call Transcript 2022-Q2

[Soren Skou, Chief Executive Officer]

Good morning everybody and thank you for joining us today for our Second Quarter 2022 Earnings Call. My name is Soren Skou, I'm the CEO of A.P. Møller - Mærsk and I'm joined today by CFO, Patrick Jany.

As you've already seen from our pre-release yesterday, we delivered an exceptionally strong second quarter 2022 with an EBITDA of $10.3 billion and EBIT of $9 billion. This is a new record for us and it's -- in fact, it's the 15th quarter in a row with year-on-year improvements in earnings.

As announced yesterday, we also increased our full year guidance to an EBIT operating result of around $31 billion. The upgrade is a consequence both of very strong Q2 and based on an expectation of an equally good Q3, driven by higher than expected contract rates in Ocean. This means that our 16th quarter with year-on-year earnings growth is in the making.

Our record of earnings growth over the last four years has been against the backdrop of US-China trade war, the shift to more expensive low sulfur fuels in 2020, and pandemic lasting more than two years and now a real war in Europe and significant inflation.

Today Maersk is a higher quality, more resilient, more profitable, and much faster growing business than we were back in 2016 when we started our transformation journey towards becoming the global integrator of container logistics.

Our strong cash flow generation in combination with a very strong belief in our business model and growth prospects allows us to increase our share buyback program and we are adding about -- adding $500 million per calendar year for the next four years for an annual commitment now of $3 billion total commitment from 2022 to 2025 of $12 billion.

Turning now to page five for some strategic transformation highlights and I will start with Ocean. The conclusion of our 2022 contracting season was very strong and better than we expected. 70% -- 71% or a little more than 7 million FFE now of our 2022 long-haul volumes are now covered in long-term contracts. 28% from these volumes are on multiyear contracts, which reprice based on rolling indices or in fixed price contracts providing greater stability of earnings going forward.

As of today, the average contract rate for the year is expected to be $1,900 per FFE higher than in 2021. The increase of $500 compared to our expectations at the end of Q1 reflects much better performance in Q2 itself, higher conclusion of deals in the latter part of Q2 and over the summer, a positive effects from higher share of contracts being hit all than expected, and a small positive buff effects.

Anticipating the Q&A session, let me add here that we are confident about contract compliance, despite spot and contract rates are now converging. Our index-linked multiyear contracts -- or some of our index-linked multiyear contracts we set here on July 1 at higher levels in a smooth and orderly process. And our block space agreements with global freight forwards contained solid debt freight language. As I have emphasized many times, historically BCO compliance has remained high.

Turning to logistics. We continue to deliver profitable growth several multiples above the market growth. In Q2, we grew revenue 61% in Logistics & Services, 36 percentage points more than half of this growth was organic and we now have six quarters in a row with than 30% organic growth. And let me emphasize that our growth is volume based and based on customer wins, not rate based in logistics.

At $3.5 billion of revenue in the quarter, our logistics business have an annual run rate of $14 billion with much more to come. 71% of our logistics growth came from our 200 largest customers in Q2. They are clearly buying into the integrated vision and want to grow with us.

We believe that we can continue to grow well above market also in the contract of a greater macro headwinds as our value proposition has a number of differentiators. First of all is our Ocean customer base with tremendous brand loyalty and an intrinsic need for all of the container-based logistics services.

Secondly, as we integrate we aim to lead the technology that provides greater transparency, flexibility and agility than what is currently available.

And finally, our control of critical assets in the supply chain, enable us to provide not only superior service and control outcomes, but also as we decarbonizes, we can provide assurance and certification, which is key in today's ESG environment.

As the numbers demonstrate, our customers are clearly voting with their wallets. We currently have 400 new customer implementations ongoing, which is as much as we can as much growth as we can safely handle.

Growth in logistics is the single biggest opportunity for Maersk in this decade. This means that for some -- at some point in this decade, we will have a bigger business in logistics than we have in Ocean today.

This quarter, we closed on the acquisition of Pilot and Senator and the integration of both is now underway. Each bonds our capabilities in logistics in a uniquely valuable way with Pilot giving us greater reach in managed transportation and B2C delivery in the US, and Senator in global airfreight.

Early in the second quarter launched Maersk Air Cargo. And combined with Senator, we are now well-placed to add the speed, flexibility and resilience of airfreight to our customers' supply chains.

We anticipate to close LF Logistics within the third quarter. And assuming we close the LF transaction at the end of this month, we are on track to become -- to come within shouting distance of $15 billion of revenue in logistics and deliver $1 billion of underlying EBIT this year.

Finally on Logistics, we are pleased that Gartner has named us a leader in their 2022 Magic Quadrant for logistics companies. In their report, Gartner highlighted our mix of organic growth and acquisitions to complete our portfolio as well as our investments in digitalization and automation, and how we leverage our -- that in our customer engagements. So this is truly a certification or a ratification of our strategy as we joined the ranks of the largest global logistics companies.

On Terminals, our Terminals business had also another strong quarter on the back of improved volumes. And if we exclude the impact of the impairment of our Russian operations, we achieved a record return on invested capital of 13.1%. APMT has now improved our returns for the last seven quarters in a row.

Now on slide 6 and I will not belabor this slide, we are -- we track our transformation KPIs on our roadmap to 2024 as we announced them at the Capital Markets Day last year. And the short -- very short version is that we are in green across the entire gas port with the terminals ROIC well ahead on an underlying basis.

Now on slide 7, let me spend a little bit of time talking about acquisitions, the logic we are applying and how we think about synergies. Acquisitions in logistics do two things for us. First and most importantly, the apt capabilities that allow us to expand our portfolio of competitive logistics products and end-to-end solutions, which is really what powers our organic growth in logistics.

Second, we add value by supercharging the growth of the acquired companies, but given the acquired company's products to our more than 2500 sales reps across the world they can sell the products to our 70,000 customers in Ocean under the Maersk brand.

We have a unique advantage that our can customers all have an intrusive need of logistics services from grades and carrier audits to customs brokers, warehousing and distribution. They also need flexibility and transparency across their supply chain, which we aim to provide not only by controlling the assets and services, but also investing in the technology to provide a full view from purchase orders to distribution center or customer or consumer door.

As we gain scale in logistics, we deepen our partnership with our customers and we are moving from a transactional Ocean relationship to a strategic partnership a more sticky relationship if you will. And we increase our share of our customers' total logistics expense, which creates a very strong platform for future growth.

As you have seen for many years now, we measure success in terms of the overall organic growth in the L&S and the percentage of organic growth derived from the top Ocean customers -- top 200 Ocean customers, which are frankly our most demanding customers.

Turning now to slide 8 for a couple of proof points. On the other right-hand chart you can see that over the last three quarters our legacy -- logistics business, which strips out the impact of all acquisitions has nearly doubled, and although our M&A colleagues have been quite busy our legacy L&S business is the main driver of our growth.

As a further proof point of our acquisition strategy, if we drill down a little further into our product families on the lower right we can see that our over the period the legacy business in our fulfilled by family has more than doubled, while performance team has shown an outstanding growth.

At this time, it's too early to tell for the more recently acquired businesses, but I have every confidence that, they too will contribute to our ambition to maintain organic revenue growth above 10% towards 2025. We believe that, this above market growth rate in logistics, because of the demand of our existing customer base.

Although, we are one of the largest ocean shipping companies. We know that, we touched only a tiny fraction of our customers overall logistics spend and that tremendously fragmented across the globe. But consolidated services and demonstrating increased utility transparency and resilience, we can build a partnership that creates value from both sides regardless of where we are the economic cycle.

Now, let me turn to page 9. And in conversation with investors in the past quarter, I was frequently confronted with questions around the development of global congestion. As we all know, congestion really ramped up last year in the US West Coast as import volumes jumped up at the same time as labor supply long shoreman truck drivers warehouse workers dropped because of COVID-19.

We had expected the congestion to ease by the mid this year, as demand would moderate. But as we can see on the left-hand import volumes into the US remain at very high levels. The situation on the ground have eased that, while congestion has eased a bit on the West Coast. Congestion has spread to the East Coast and to Europe, even European volumes are essentially in line with pre-pandemic levels. But containers are just not moving off the terminals as fast as we would like to see.

One simple example on the West Coast, we have massive problems getting railcars. Yesterday we had 8,500 containers in our Los Angeles terminal, waiting for railcars which is three times or four times the average railcars from a few years ago. Across the East Coast, the West Coast and Europe we see issues in getting enough labor to trucks and with customers not picking up containers, because of full inventories.

The picture means that, a quick resolution of a global supply chain issues is increasingly unlucky, but we do expect that we will see a gradual normalization from the fourth quarter towards the end of the year as headwinds keep demand down and labor markets become less tight.

Now moving on to sustainability and a few highlights, our ECO Delivery product continues to show excellent traction with customers. We are delighted that we have been able to accelerate with our volume growth. And we now have more than four times – they are now more than four times higher than the previous year's same quarter. That's the definition of exponential growth.

ECO delivery now represents nearly 2% of our Ocean volumes. And as an important proof point of our ECO strategy customers accepted that carbon neutral delivery does come with a higher price point. This price signal is key for us and for the entire market as we move towards a carbon-neutral future.

We'll discuss sustainability targets and progress in detail at our ESG Day November on November 22. But of course, we are working towards the golden net emissions by 2040 every quarter now across the entire company. In Q2, APMT switch to running eight of our European facilities on renewable electricity. And while APMT is a small part of our corporate emissions for the division it represents a significant step towards the segment goals and every step counts.

So, before I hand over to Patrick on slide 10, you will find our guidance for 2022 which we revised and upgraded yesterday. This upgrade of means that, we are guiding for another super strong year for Merck. Based on our volume decline in the first half and expectations for the rest of the year, we now expect global container demand growth to be essentially flat or slightly negative for the year.

Our other guidance elements such as CapEx remain unchanged. On the right-hand side of this chart, you see our 2022 agenda items, they remain unchanged. And I'm pleased that, in this quarter, despite the extreme challenges faced all of our Maersk colleagues, have put together to produce significant tangible progress, across all categories and segments.

And with that, let me hand over to Patrick.

[Patrick Jany, Chief Financial Officer]

Thank you, Soren. And let me add my welcome and thanks to listening today. Let's, jump straight into the next slide, for the financial highlights of the quarter. As Soren just said, Q2 has again hit to record across all performance metrics, starting with revenue growth of 52% to $21.7 billion. Similar to the previous quarter, high freight rates in Ocean, were the main driver, but higher volumes in Logistics & Services and Terminals again, contributed to the strong revenue performance.

We once more achieved a record quarterly profit level, with an EBIT of $9 billion, more than doubling the previous year number of $4.1 billion. This led to a net result of $8.6 billion for the quarter. To put this in context, it means that in the first half of 2022, we achieved a net result of $15.4 billion, coming very the full year 2021. This continued high profitability, also increases returns, generating tremendous value generation, both in terms of increased ROIC, now reaching 62.5%. And cash flow, with a free cash flow generation of $12.8 billion in the first half, allowing to more than cover the $8.1 billion of returns to shareholders, in the form of dividends and share buyback and acquisitions for $2.1 billion.

Looking at our cash generation in more details on Slide 14. We see that we had a strong operating cash flow of more than $8 billion, equivalent to a cash conversion of 83%. This is in line with the previous year, and a slight decline on a sequential basis, as working capital has been increasing with increased revenue. Our gross CapEx was $1 billion, in line with our expectations and primarily went towards new aircraft equipment and replacement of vessels. This resulted in $6.8 billion of free cash flow, of which this quarter $2.1 billion went towards the closing of Pilot and Senator, it is actually composed of the $1.5 billion cash purchase, you see in the graph and $600 million in debt settlement on the previous last column, at closing.

In addition, another $1.5 billion was distributed in the form of share buybacks, and the payment of withholding tax on behalf of shareholders. In terms of resulting cash position, we have increased our net cash balance, after lease liabilities to $3.4 billion, which means we actually have cash of $19 billion, accounting the cash on balance sheet and the short-term deposits. This clearly, allows us to look confidently, at the years ahead and it allows us to further invest in organic growth, in target acquisitions, while offering attractive returns our shareholders, as exemplified by the announced $2 billion increase of our four-year share buyback program, meaning $3 billion yearly returns for the years 2022 to 2025.

Now let us turn to the development in each of our segments, starting with Ocean on Slide 15. As Soren covered earlier, Q2 saw a continuation of the global congestions, with an accumulation of several disruptions, offsetting the weakening demand and lower economic outlook and implying still a very high level freight rates. Although spot rates softened slightly, during the quarter, they remained high in absolute terms, and we continue to sign contracts at higher rates than previously, leading to an average rate increase of 64% compared the previous year. This triggered the 57% increase in revenue, despite 7% lower volumes.

Consequently, our Ocean segment produced a record EBIT of $8.5 billion in Q2, with a record high margin of 49%, as the increase in freight rates both compared to previous year and sequentially has overcompensated the increase in costs. On Slide 16, we show this evolution visually, with on the one hand the strong positive impact of rates, complemented in other revenue, by some release of revenue recognition, as volumes were down. And on the other hand, the offsetting lower volume, the higher bunker price and the increasingly container handling and network costs when compared to previous quarter.

Turning to Slide 17. Our freight rates increased by 64% compared to prior year, and 14% sequentially. This increase was driven by the long-haul contract rates as the short-term rate actually flattened, meaning that both rates were converging in Q2 indicating that while demand outlook is certainly down, why is disruption preempted the wider erosion of freight rates, which led to an overall market development, which was very similar to that of the first quarter 2022 with both higher rates and lower volumes.

In this environment, we continued to increase capacity to alleviate the bottlenecks with a further 4% added when compared to a year ago. Sequentially, capacity stabilized at the 4.3 million TEUs, the upper end of our capacity limit. And loaded volumes increased slightly by 3%, while service delivery remained industry leading but still at rather low level.

As a continued of our strategy to be a reliable partner of our customers, the contract signing was strong. And we now have 1.9 million FFEs on multiyear contracts, a sequential increase of 19% and sharply up compared to the one million FFEs in the second quarter of last year.

Moving now to slide 18. Let us spend a moment on our operating costs. The main driver of the 18% operating cost increase this quarter is a 69% increasing bunker, which is actually due to a 74% increase in the cost of fuel, which is slightly offset by a 2.7% reduction in bunker consumption. The cost increase is being passed through in the form of our past closes with the adjustment progressively coming through in the second and the third quarter.

Other costs were up by 5.6%, which combined again with the lower volumes led to a 14% increase in unit cost at fixed income. It is important to note that while as we guided for earlier, one-third of this cost is certainly due to congestions related costs like container handling costs for instance and is expected, therefore, to recede as soon as the situation normalizes. The rest of the cost increases will actually continue to see inflationary pressure in the coming quarters.

As a side note for the quarter, you will have noticed that we were more successful than initially anticipated in evacuating containers from Russia, which has allowed us to reverse part of the impairment made in Q1.

Now turning to logistics services on slide 19. We are very pleased that demand for our logistics solutions continues to be very strong, allowing for dynamic growth in both revenue and profit of 61% and 53%, respectively. Revenue reached $3.5 billion, an impressive number in this quarter.

In this quarter we also closed the acquisition of Pilot and Senator, which add incrementally to our capabilities as Soren touched on earlier. The integration of both has begun. And in particular we are looking forward to leveraging Senator's CargoWise straightforward IT platform for our air freight business. And overall acquisitions this quarter contributed to 25% of the growth reported.

Looking now at the development on slide 20 of the three product families. We see a very strong growth in the integrated products and services managed and fulfilled banners. In managed by Maersk, revenues reported a growth of 80% to $570 million, driven by lead logistics, which was able to increase revenue in both existing and new customers.

For fulfilled by Maersk, revenue grew an impressive 84%, accelerating off a strong base as our contract logistics business benefited from new warehouses openings and strong customer demand. Profitability weakened slightly with an EBITA of 3% given a still weak e-commerce environment and the ramp-up of significant new contracted capacities.

Finally in transported by Maersk, revenue growth was strong at 50% with higher volumes in landside transportation and air freight rates as well, contributing to both higher revenue and profitability. In terms of airfreight volumes specifically, the consolidation of Senator's airfreight drove almost all of the 45% increase we saw in the second quarter.

On slide 21, we turn to terminals, which had another very strong quarter driven by higher rates, higher volumes and storage related revenue. Non-operational one-offs and higher costs affected the other margins, although the ability to link tariffs increase to CPI is very positive and will help to mitigate cost increases going forward. The outlook is therefore solid as well. CapEx rose significantly compared to previous year quarter, linked to the expansion particularly in the US in Mobile Alabama and the other two terminals in the US, as we work to meet increased import demand and improved terminal performance.

Turning to Slide 22, which was some detail on the Terminal's results. Volumes reflect a strong demand and were up by 1.5% or actually 3% on a like-for-like basis, when adjusting for exits and expiring concessions and average utilization was up to 79%. As the EBITDA bridge for Gateway terminal shows, EBITDA increased 8% versus the prior year, driven by the underlying business improvement and the impact of higher storage, yet mitigated by higher costs. Revenue per move increased by 13%, which is the same pace as costs allowing to offset the pies cost increases and one-offs that occurred in this particular quarter.

To finish up on Slide 23, we have a summary of our main activities in the new Towage & Maritime Services segment. Segment revenues grew by 9.5%, primarily driven by good performance at Svitzer and increased project activity as Merck Supply Services. Higher bunker costs low and impairments in our financial participation in auto liners had a negative impact on the segment profitability. But our actual business operation contributors Svitzer and MSS were stable or improving. As mentioned in Q1, MSS is on an important contract with the Empire offshore wind project in this quarter saw the first down payment for patented vertical installer solution.

Now that we have run through the segments. I'd like to hand over to the operator for the Q&A session.

[Operator]

[Operator Instructions] Our first question comes from the line of Sam Bland at JPMorgan. Please go ahead. Your line is open.

[Sam Bland, JPMorgan]

Hi. Thanks for taking the question. Just one for me and I know you touched on it. But I think on the multiyear contracts some of price I think on the 1st of July. I think I'm right in thinking that the rate on those increased on the 1st of July. Could you just talk about how the customers view that when they could obviously see spot rates coming down? Will they took to discussions, or does it generally go through quite smoothly? Thank you.

[Soren Skou, Chief Executive Officer]

Yeah, you're right. Some of the contracts did reprice here on the first of July. And yes, they did and we had a relatively smooth and normal discussion about that. Our customers know very well that an index-linked contract can go both ways. And that's what the -- that's why they are choosing to have an indexing contract because they are then not playing if you will so much in the freight market, just in the same way as we think about our bus clauses.

[Sam Bland, JPMorgan]

Okay. That’s understood. Thanks very much.

[Operator]

Our next question comes from the line of Michael Vitfell-Rasmussen of Denske Bank. Please go ahead. Your line is open.

[Michael Vitfell-Rasmussen, Denske Bank]

Yes. Thank you very much. We're seeing growing tensions in the Taiwan Strait. I understand that this is a very important route for especially Asia to Europe. Assuming, we see an escalation in the area, is this something, which you think will lead to new or building up even further in terms of the congestion and vessels of the freight rates? And if you could kind of add some comments on it in terms of how much local capacity will that potentially take out of the of the supply side please?

[Soren Skou, Chief Executive Officer]

It's very hard for us to speculate and we do not know what the Chinese plans, it's clear that there will be a response to speaker Pelosi's visit to Taiwan and it seems like it will be some military exercises, but this is not something we have particular insights on. The Taiwan straight is one of the most busy straights in the world. So, obviously, if it were to close, it would have a dramatic impact on shipping capacity in the sense that everybody would have to divert around Taiwan and add to the length of voyages and that would absorb a significant capacity. But I also have to say that there seems to be no suggestion that that's where we are going.

[Michael Vitfell-Rasmussen, Denske Bank]

Great. Thank you, Soren.

[Operator]

Thank you. Our next question comes from the line of Robert Joynson of BNP Paribas Exane. Please go ahead. Your line is open.

[Robert Joynson, BNP Paribas Exane]

Good morning everybody. A question on the balance sheet please. So you had around $9.7 billion of cash and bank balances as of the in Q1. But on top of that I estimate there was around $9.5 billion of cash and equivalents, i.e. in terms of the short-term deposits that you referenced on Slide 14 of the presentation. So in terms of cash and cash equivalents, I think, that the total was about $19.3 billion at the end of Q1.

And just looking at the guidance I'd be assuming that number will go to kind of $30 billion or maybe something closer to the mid-30s by the end of the year. So that compares with Captain equivalent of just $4 billion to $5 billion before the pandemic. So, maybe a delta of $25 billion to $30 billion in excess of that by the end of the year. So sorry to throw out so many numbers here, but there's going to be a lot of cash and equivalents on the balance sheet by the end of the year in that concept. Could you just talk about what Maersk balance sheet policy is at the present time? And with share backs effect has been maxed out what are the implications for special dividends? Thank you.

[Soren Skou, Chief Executive Officer]

Yes. Thanks Rob for the question. Indeed the -- your math is correct. So I mentioned, I think, earlier on that we have more than $19 billion cash by the end of Q2. When you actually count those the elements precisely as you do which in the cash posts as well. So, it is a good balance of cash clearly, which will continue to strengthen in the second half given our guidance. So you're totally correct on that.

I think when you look at the cash looking forward there are two components here. One is our return to shareholders, which we have increased with an increased share buyback. But also, obviously, they're not ordinary dividend right which is a significant component.

As you know last year, we distributed 40% of all the profit back of the 2021 numbers. It is a Board decision, but I guess it will be something in the same order of magnitude for the result of 2022. So that's in any case whatever the exact number is a significant outflow cash in the first quarter of 2023.

And then when you look at the balance sheet policy per sequential, I think, it is clear that we have the policy at the 2024, 2025 horizon post-normalization, right? So you know that clearly the current cash generation is slightly in excess of what is to be expected in a more normalized environment. So we look forward to have a very strong balance sheet, strong BBB once situation has normalized. That is how we say we look at it.

This clearly leaves a lot of cash but we will invest in further growth and organic growth in logistics. We certainly will continue to have a very targeted approach in logistics to reinforce our position there and the fabulous growth, which we are having there. And that probably will leave as well some further return to shareholders, but we'll talk about it once the cash is really in the house and we see our normalization sells.

[Robert Joynson, BNP Paribas Exane]

And maybe you say, very quick if I may. You've previously talked about the largest acquisition that you consider in kind of low billions of dollars. Is that still the case or thinking all in that respect?

[Soren Skou, Chief Executive Officer]

No, I think, we haven't changed our view on acquisition. We are in a phase where, I think, we have prioritized capabilities at gaining acquisition, which implies that they are more focused, because they address the lack of capabilities we have. So they are I would say more targeted companies, which are good, well-run companies, which we can really integrate and pass our volume through as we always say boost our -- their turnover by channeling our volumes there to the activity. So that limits, I would say, probably as well as the score and we are still in that phase.

[Robert Joynson, BNP Paribas Exane]

Great. Thank you very much.

[Operator]

Thank you. Next question comes from the line of Alexia Dogani of Barclays. Please go ahead. Your line is open.

[Alexia Dogani, Barclays]

Yes. Good morning. Thank you for taking my question. Just kind of a more broad question in terms of tax. Clearly, we're seeing energy companies and the subject to windfall tax because of the contribution to cost inflation, do you see any risk in terms of a windfall tax potentially in container shipping given the current circumstances and the basic position of this very high extraordinary profits. Thanks.

[Soren Skou, Chief Executive Officer]

Well, I mean, all I can say is that we are not aware of any discussions about windfall tax that would be -- that would impact A.P. Møller - Maersk. But I mean, we are, of course, aware of the almost global discussion about tax on container shipping. Yes, that's all I can say. We're not aware of any initiatives at this point.

[Operator]

Thank you. Our next question comes from the line of Ulrik Bak at SEB. Please go ahead. Your line is open.

[Ulrik Bak, SEB]

Yes. Hello, Soren and Patrick. Also a question from my side. In your updated guidance, you state that it is based on a gradual normalization of Ocean taking place in Q4. And we have seen rates decline throughout July, which I would define as partly normalization. But I'm just curious to hear what your definition of normalization is? And what you have assumed regarding the rate level and trajectory for the rest of the year in Q3 and Q4? Thank you.

[Soren Skou, Chief Executive Officer]

Yes. So, to give you a bit of color on that, I think we have clearly said as well that we expect Q3 to be strong, right, to be in line with Q2, given the visibility we have on the quarter, which really focuses the uncertainty of the guidance on the Q4. And there we take the assumption and we actually expect that the freight rate normalization takes place.

As you have mentioned and we have seen right in the last few months, there has been an erosion of the short-term rates, which has been stopped here and thereby renewed or new disruptions. But fundamentally, we can escape the macroeconomic environment, which clearly had a lower higher inflation lower consumer confidence.

So, if you look at all those indicators, I think there's really any doubt on where the global economy is going, right? So there will be a reduced demand at one point in time. But we would expect for all the factors, which we typically have, as we discussed earlier on, that this will be a gradual development and that ultimately as well freight rates will stabilize at a higher level than they were in the past and higher than the cost scale, which is basically what we said as well back in Capital Markets Day in 2021.

And for the Q4, I think what we have said and we have changed our guidance. We had a guidance of saying we mathematically assume a sharp decline by 1st of July, just because we had no indication of how it could go. So in our previous guidance we said, well, let's say, two good quarters and then two bad quarters by assuming that the monetization happens by 1st of July so that everybody can take their own assumption and calculate with our view.

Now we take a view on the fourth quarter and we assume that what we have seen in the last few months of an erosion of short-term will actually continue to happen. So, not a one-day drop, but a progressive erosion towards that lower level of short-term rates in Q4. So, that's our [indiscernible].

[Patrick Jany, Chief Financial Officer]

Yes. If I could just add one very small comment. I mean we did $19.4 billion of EBITDA in the half. We are seeing a similar quarter in Q3, so around $10 billion that would get us to $30 million and we are guiding for $37 million. So that's the extent of the normalization. And obviously, that's because we see portfolio keeping if you will a steady high floor under the earnings of Maersk in the coming quarters. Thank you.

[Operator]

Thank you. Our next question comes from the line of Muneeba Kayani at Bank of America. Please go ahead. Your line is open.

[Muneeba Kayani, Bank of America]

Hi, Soren and Patrick. So, just following up on your comments on the contract rate. One quick clarification on the $500 increase, the $1400 going to the $1,900. How much of is due to the bunker clause? And then just on contract like how should we be thinking about contract discussions for 2023?

If I remember correctly last year you said some of the discussions have started earlier and you've seen some of the benefit from those higher rates in the fourth quarter of 2021. Is that right? And kind of how should we be thinking about the 2023 contracting fees? And based on your expectation that part were to decline in the fourth quarter. Thank you.

[Soren Skou, Chief Executive Officer]

So, on the BAF question it's a minimal impact less than $50 out of the $500, but still worth mentioning. In terms of 2023, I'm sure we'll get several questions that will try to draw us into giving some kind of guidance for 2023, which we will only do in February.

And the only comment I have is that obviously the higher the freight rate environment is when negotiations are taking place the more likely, the contract rates are to roll over or to settle at a still very high level. But it's too early to tell we will negotiate that in the fourth quarter for many of them. Thanks.

[Operator]

Our next question comes from the line of Lars Heindorff at Nordea. Please go ahead, your line is open.

[Lars Heindorff, Nordea]

Thank you, Soren and Patrick. I got a question regarding the guidance and the difference between the upgrade in EBITDA and EBIT, which is $7 billion and the increase in the free cash flow guidance, which is sort to say just $5 billion, the difference $2 billion.

Surely, so I mean some of that can maybe be explained by more net working capital as long as rates stay at these levels here. But can that explain the whole difference of the $2 billion? Thank you.

[Soren Skou, Chief Executive Officer]

Yes. Thank you. Lars coming to your question, I think it's not unusual for us. If you actually look at the last increase we did in Q1. We also increased our guidance of EBITDA by $6 million the time if I remember correctly and the cash flow by $4 billion, so we had a $2 billion difference. And you see the same difference now as well with this increase.

And that is mainly due effectively as you correctly mentioned by increased working capital. I think what we see obviously we are having a higher revenue then obviously, we thought that generates already at the same amount of days of sales outstanding higher absorption and then therefore lower cash generation when you compare with the EBITDA.

Then we have had a few days more of DSOs in some part of the business which we obviously are monitoring but there's certainly a trend here of increasing trade receivables which is not uncommon when the economic outlook comes down. So something we are certainly monitoring.

And I must say as well we probably will have some here and there some prepayments to secure as well lower cost bases in the future, which is also I think a good way to handle our P&L and a good use of cash as well.

So, those elements I think are the main deviation here, which has been a lower conversion let's say in terms of incremental EBITDA towards incremented cash.

[Operator]

Thank you. And our next question comes from the line of Parash Jain at HSBC. Please go ahead, your line is open. Parash, if your phone is muted, you need to unmute that.

[Technical Difficulty]

[Operator]

Okay. We'll have to go to the next question; your line seem distorted there Parash. Okay. Next question comes from the line of Carolina Dores at Morgan Stanley. Please go ahead, your line is open.

[Carolina Dores, Morgan Stanley]

Hello. Good morning everyone. Thanks for this. I guess my question it is on 2022, but more on the supply side than on the demand. We are now in August, so I guess future has a better handle on the effects of the IMO 2023 from -- how are you compliant with the increase in energy efficiency in the CII index? And how do you think the industry is prepared? And what do you think the effects are going to be of the implementation of the IMO 2023, I guess, path to decarbonization metrics?

[Soren Skou, Chief Executive Officer]

Yeah. Thank you. This is a relatively new if you will legislation and we're still trying to figure out what the impact will be on supply. Because there are different ways of improving the energy rating of old ships. You can use biofuels, you can slow down speed will be the two most obvious ways of moving the energy rating from a D to a C.

And we have only at this point some if you will very high-level numbers based on our own fleet. But it looks like in order to comply we will need somewhere between 5% and 15% more capacity. If the response -- if the way we comply is by lowering the speed, so 5% to 15% more capacity, up towards 2030.

So this will only -- with that being said, so that is actually a quite significant impact if the compliance is based on slowing down speeds, which we think is the most likely given the shortage of biofuel and price of biofuel. But quite of course that's still outstanding.

Now what is also outstanding is a clear understanding of how this will be enforced and the timelines. And as far as we understand it now it will only really be enforced from 2024 or 2025. And therefore the short-term impact may be very limited. But longer-term it's actually -- the way we understand the regulation at this point are quite significant.

[Operator]

Thank you. Our next question comes from the line of Dan Togo at Carnegie. Please go ahead. Your line is open.

[Dan Togo, Carnegie]

Yes. Thank you question along those same lines, because everybody is looking at the many orders that have been placed for new capacity getting more at 2023 and 2024. And as you just alluded to here we have an IMO2023 coming up taking out capacity. We also have software demand and we potentially have been scrapping.

So how should we look at the market balance going forward and the impact it will have because -- and don't be -- is the risk as the added vessels coming on stream they probably are just going to make things worse in terms of congestion.

I mean the province today, are not like a vessel basically, it's basically the ports and the intermodal part. So how should we view this if so let's say, 2023 and 2024 I would love your view on that? Thanks.

[Soren Skou, Chief Executive Officer]

What matters in our view in container shipping is not so much how many ships exist. What matters is how much capacity we deploy in our networks, compared to the demand that we have.

And if you to 2020, we saw that in action very clearly, because in the second quarter -- in the first quarter demand was down. In the second quarter demand was sharply down by 15% global demand, but prices stayed flat because all of the networks adjusted capacity and basically item the tonnage that was not needed.

And certainly going forward will also be our philosophy in, how we operate the network that we will provide the capacity that our customers need but we will not sell all the capacity that we have unless there's demand for it. This is very similar to the way the Korea express package operators they operate their networks.

They're not flying the airplane they've got no packages. And so that's what I see for this industry going forward. Clearly this is assuming that everybody will continue to operate networks the way they do today, but I see little reason to think that people would do something different. Thank you.

[Operator]

Thank you. Our next question comes from the line of Sathish Sivakumar of Citi. Please go ahead. Your line is open.

[Sathish Sivakumar, Citi]

Thanks again for taking my question. So finalized regarding the international cargo they issued the authorities due to the transshipment between two Chinese port. Could you actually explain what does it mean for you and actually for the other foreign carriers? And what will be the likely impact on capacity and ease and congestion? Thank you.

[Soren Skou, Chief Executive Officer]

Transhipment of Chinese containers in China means that, we are moving the transshipment from -- basically from Busan in Korea or Hong Kong or somewhere else, Japan to Shanghai and will shorten, if you will a bit the distances. But in terms of overall impact on capacity and so on for the industry, I don't will be in have a meaningful impact.

[Sathish Sivakumar, Citi]

Okay. Thanks.

[Operator]

Next question comes from the line of Anders Karlsen at Kepler Cheuvreux. Please go ahead. Your line is open.

[Anders Karlsen, Kepler Cheuvreux]

Thank you. I have a question on volumes. I mean in your guidance you alluded to a small decline in volumes for this year. But still that means that volumes are going to be up in the second half compared to the first half, what are you seeing in terms of volumes into Q3? And are you expecting a seasonal improvement in volumes towards end of the year here?

[Soren Skou, Chief Executive Officer]

Yes, I think there's a momentum here to highlight to your point is that, obviously you have to consider the previous year basis, right which makes an optical change here. We actually do not see volumes coming up significantly in the second half. It's just probably the reduction will be lower because the volumes in the previous year were low as well, right?

But the environment we see today is very much a continuation of Q2 which is a reduction of volumes pretty much. Mainly, I would say towards Europe and on the back exports from Europe into China and also quite a weak North, South and that is expected to pretty much continue this year.

[Operator]

Thank you. Next question comes from the line of Cristian Nedelcu of UBS. Please go ahead. Your line is open.

[Cristian Nedelcu, UBS]

Hi, thank you for taking my question. Maybe one on North-South rates. I think over the last months on the spot rates, we have seen some meaningful increases on the routes like Asia to LatAm or Europe to LatAm. And this seems to be indicating that Q3 rates are going to be higher than Q2. So just wanted to confirm, if you indeed you're seeing this in your portfolio and maybe if you can give us a bit more granularity on what is happening demand and capacity-wise on these trade lanes? Thank you.

[Soren Skou, Chief Executive Officer]

Thanks for your question. I think we can just probably maintain what we just said on the earlier question, right? I mean North-South has been actually quite weak. It always depends a bit on how capacities are reallocated. But we don't see that there is an upswing so to say, from the macroeconomic point of view which would underline a durable increase.

So, there will always be variations back and forth depending on the reallocation of vessels. As you know, many vessels have been transferred from those trades into the Asia trade to make more capacity that can go some disruptions here and there. But overall, we don't see that as a major component for the evolution of the rates looking forward.

[Operator]

Thank you. Our next question is from Muneeba Kayani Bank of America. Please go ahead. Your line is open.

[Muneeba Kayani, Bank of America]

Thank you. I just had one more question from the demand side. So you're seeing good volumes still in... [Technical Difficulty]

[Operator]

It looks like line is disconnected. The next person is Lars Heindorff. Please go ahead. Your line is open.

[Lars Heindorff, Nordea]

Thank you. So, it was actually for you because I think in your opening statement, you mentioned that you were very confident about contract compliance. I don't know how far you believe this is compliance will extend. But if you look into next year '23, I mean what are the reasons here why you are so confident in that? I mean historically, contract compliance has not been very good in the industry. So, I mean views on for the moment changes which makes you so certain about this compliance?

[Soren Skou, Chief Executive Officer]

Well, I think I mean the confidence applies to the contracts that we have, right? So however long they run, most are one-year contracts and some are multiyear contract. I think what's important to understand, when we look at our portfolio today is that, our portfolio is heavily weighted towards BCOs, and they have a traditional been quite compliant in contracts. And the risk has been more -- basically only on the volume, not on the price.

And then, when it comes to the contracts, we today have with the global freight forwarders, they have dramatically changed in the way they are structured. So, it is a block space agreement. It is take or pay, the language is very, very clear. There's a debt rate provision and so on. And we are building our freight forward clients for this. So that's why we believe we have high contract compliances. It’s a very different scenario from when almost half of our business was with freight forwarders which is not where we are today.

[Lars Heindorff, Nordea]

Thank you.

[Operator]

Thank you. We've been able to get Muneeba back on the line, apologies to those technical issues. So, Muneeba Kayani of Bank of America. Please go ahead. Your line is open.

[Muneeba Kayani, Bank of America]

Thank you for that. I'll just repeat because I don't know where I was cut off. So, I was just asking around the demand picture. So what we've seen from the headlines -- from the big US retailers is about inventories building up and kind slower consumer demand. And what we're seeing in the numbers on import volumes into the US as you mentioned. Those remain quite strong. So, how should we square this off? Is there a lag in terms of timing? Is there a mix effect? How are you thinking about it? What are you seeing? We'd love to know.

[Soren Skou, Chief Executive Officer]

A couple of effects effectively. Some of the inventory that we see particularly in the US where there's good data is, if you will the wrong inventory. So our customers are complaining that they have the wrong inventory. And still it has to import if you will the right inventory. And the other effect plays at certain product categories, especially in the durable goods. I mean pretty much everybody have bought the new couch, the new set of lounge furniture, the new TV screen, whatever, all the things that we were all spending our money on during the pandemic. And that means that they cannot be -- you're not going to buy another TV screen, right? Whereas a lot of the fast moving stuff and especially in the retail, lifestyle and retail goods actually there's still very strong demand and we see our customers being very busy in terms of imports to the US.

So these are some of the effects that are at play. But with inflation and also being rampant also in the US, people are able to afford less than they were a few months ago and that should have point any impact on the US imports. The only caveat to that is of course that the savings are also very, very high. And money-wise, people have said that we should always be careful not to count out the US consumer. But one would think that demand would come down also in the US because of inflation.

[Muneeba Kayani, Bank of America]

Thank you

[Operator]

And we have time for one further question. That's from the line of Marc Zeck of Stifel. Please go ahead. Your line is open.

[Marc Zeck, Stifel]

Yes, thank you for taking my question. Just a short one on capacity employed that you see in the market, especially on the term specific. I feel there's a bit of confusion with employed capacity for peak season for August is actually up or down? What do you currently see in the market in terms of capacity offered on this strengthen for beginning of the peak season? Thank you.

[Soren Skou, Chief Executive Officer]

I'm not sure we have that data. I think what we can say for Maersk is that we have significant grown the capacity that we have deployed in the Pacific to meet customer demand. We probably have 50% more capacity in the Pacific today than we had in 2019. And it is actually the one of the reasons for why our volumes are – have been dropping this year because we – we're taking the capacity from the interregional trades, where we have more container turns so to see per ship per year and moving those ships into the Pacific, where they have less turns per year. But so we have much more specific capacity but I can't say I don't know about the market. Thank you.

[Soren Skou, Chief Executive Officer]

And now with that let me leave you with a few final remarks. So we are of course pleased that we present yet again another record quarterly financial results. It's driven by continued exceptional market conditions but also – and I think that's very important for us fundamental progress in our transformation strategy.

We see continued global congestion. It's – and it's not likely to clear up in the very short term. And combining that with a successful closure of our 2022 contract decision that allows us to increase the full year guidance, as previously announced and the strong cash flow generation allows us to increase cash return to shareholders through the share buyback program.

Even so, this increase leaves us with ample funds to continue our investment into organic growth and especially in logistics services as well as continue what we believe is a quite successful acquisition strategy. With the markets normalize in the coming quarter in the coming year, we will continue to work towards a closer partnership with our customers with the improvement and resilience and sustainability of the world's supply chains and our business.

In closing, I would like to highlight our refreshed corporate purpose, which we launched this year and thank all of the Maersk colleagues worldwide for their dedication and efforts as we seek to improve life to all by integrating the world. Thank you and look forward to talking to you again in the next quarter.