Russia's Transportation Renaissance

Russia’s insular transportation industry is belatedly opening up to the outside world as the nation’s thirst for imported goods slots it into global supply chains.  

State-owned Russian Railways plans to bid for ports and rail assets being sold by cash-strapped Greece. The new CEO of Fesco, operator of the country’s largest ocean carrier, is a former McKinsey & Co. partner with degrees from universities in Texas and Missouri. Nefte Trans Service, a private rail freight operator, is expected to launch a $500 million initial public offering on the London Stock Exchange where several Russian rail and port operators are listed.     

APM Terminals’ $860 million acquisition of a 37.5 percent stake in Global Ports last September is the largest direct foreign investment in Russia’s transportation sector to date and could pave the way for further big-ticket deals from abroad. That the deal was announced in a filing to the London Stock Exchange, where 25 percent of Global Ports’ stock is traded, testifies to the growing international outlook of Russia’s transportation industry.

Russian ports and rail freight companies, now mostly under private ownership following sweeping deregulation and privatizations over the past decade also are accelerating consolidation to boost market share and reap economies of scale. Summa, a $10 billion-a-year energy, telecommunications and engineering conglomerate, acquired control of Fesco, operator of Russia’s largest ocean carrier, in December. Global Ports is negotiating a $1 billion-plus takeover of National Container, Russia’s biggest container terminal operator. Globaltrans, a rail freight company that’s also quoted in London, was forced to deny recent market talk that it’s weighing a bid for Nefte Trans Service, its closest rival.

Russian oligarchs have benefited from deregulation to build large rail freight portfolios, underscoring the financial potential of the transportation sector. Universal Cargo Logistics, owned by billionaire Vladimir Lisin, controls a fleet of 200,000 railcars following its acquisition of Freight One from Russian Railways.

Other operators have expanded by acquiring the captive rail units of industrial companies, but this is a diminishing source of growth, with steelmakers Severstal and Mechel among the few major companies yet to shed these non-core assets. This has enabled some rail operators to post spectacular growth rates, including NTS, which was founded by four entrepreneurs in 2006 with a fleet of 400 railcars and today operates 57,000 units transporting more than 8 percent of Russia’s rail cargo traffic.

The slowing Russian economy likely will accelerate mergers and acquisitions. “The current market environment may well be a catalyst for further consolidation,” Russian freight rail operator said in March. “Smaller rail operators are increasingly deprived of access to premium cargo bases as well as being impacted by recent market headwinds.” Earlier in that month, Globaltrans completed a $335 million acquisition of MMK-Trans, which operates 3,500 railcars serving Magnitogorsk Iron & Steel.

Russian Railways, whose cargo market share dipped below 50 percent for the first time in 2010, has been selling off some of its freight subsidiaries, but it’s also leveraging its massive financial strength to move into new markets, at home and abroad. It signaled its international ambitions with November’s $1.25 billion takeover of Gefco, the transportation and logistics arm of French automaker PSA Peugeot-Citroen, which it portrayed as the first step in its bid to become a global logistics giant like Germany’s Deutsche Post DHL.

The company now is turning its attention to Greece, where it plans to bid for the bankrupt nation’s second-largest port, Thessaloniki, and two rail service and maintenance companies worth an estimated $185 million.

In another sign of Russia’s more outward-looking stance, Russian Railways said it’s ready to bid with a foreign partner, Reseau Ferre de France, though the Russian company’s hands are tied by the government, its sole shareholder, which will have a say in any decision over foreign investments. The Kremlin, however, plans to loosen its grip by unloading a 5 percent stake by the end of 2014 and another 20 percent two years later.

Rail owes its massive 85 percent share of Russia’s freight market to the huge track infrastructure built during the Soviet era and the poor state of the nation’s roads and neglected inland waterways that makes it the only form of transportation for large areas of the vast nation.

This imbalanced modal split has hindered the growth of Western-style third-party logistics, with many companies forced to arrange their own transportation and distribution. One of those shippers is Magnit, a fast-growing budget supermarket chain that operates a fleet of 4,500 trucks to supply its 7,100 stores.

A recent survey by global real estate company Colliers International put Moscow and St. Petersburg at the bottom of 40 European cities for logistics competence, highlighting the yawning gap between Russia and the rest of the industrialized world.  

The air freight industry’s move abroad to keep pace with Russia’s expanding trade links has had mixed results, with the largest operators struggling to survive in the depressed global market. Aeroflot is mothballing its three MD-11 freighters, and Polet Airlines reportedly told customers it will ground its three IL-96 aircraft because of sluggish demand and low rates. Volga-Dnepr’s core Antonov-124 charter operation has seen a sharp decline in heavy-lift and project business, and AirBridgeCargo, its ambitious scheduled airline unit, is facing tough times as it struggles to fill its expensive new 747-8 freighters.

Worse, just weeks after it acquired a 49 percent stake in AirCargoGermany in April, the carrier was grounded after an audit by German aviation authorities showed it didn’t have sufficient cash to operate over the next 12 months. The outlook for freighters in the domestic market is even grimmer as passenger airlines boost their belly-hold cargo capacity as they renew and expand their fleets to meet the demand from Russia’s growing middle class.

Russia’s ocean container market has posted average annual growth of more than 15 percent in the past five years, but domestic ship owners have failed to take advantage even on the booming feeder trades from North European ports such as Hamburg. Even as trade expands, Fesco recently announced it had sold half of its fleet as its shipping unit moves from owning and managing ships to supporting liner and logistics operations.

The transportation sector is bracing for tougher times as the Russian economy, which was growing about 7 percent annually a few years ago, is stalling. Growth in the first five months of 2013 slowed to 1.8 percent compared to 4.5 percent in the first half of 2012, partly because of shrinking demand for energy and raw materials, key rail cargoes.

Russian President Vladimir Putin acknowledged that inadequate transportation infrastructure is a major obstacle to economic growth when he announced a $14 billion investment in three massive projects, including an upgrade of the Trans-Siberian Railway, at June’s St. Petersburg Economic Forum.

“Our key challenge in the coming years is to remove many infrastructure restraints that literally stifle our country and prevent unlocking the potential of our regions,” Putin told foreign business representatives attending the forum. The Kremlin also is prepared to spend up to half of an $88 billion reserve fund on infrastructure, he said.

There’s no denying the pent-up potential of Russia’s underdeveloped transportation sector, particularly if the Kremlin accelerates privatization and deregulation and makes good on its investment pledges.

A.P. Moller-Maersk is in for the long haul, eyeing further investment opportunities, even though Global Ports shares have fallen more 10 percent since it acquired its stake in September. “Irrespective of the fact the market has been cooling, we continue to be convinced that Russia is a growth economy and the increase of the middle class will give a basis for continued growth,” CEO Nils Smedegaard said.

Smedegaard, who attended the St. Petersburg Forum, said he would not exclude any of A.P. Moller-Maersk’s units — Maersk Line, APM Terminals, Maersk Oil and Maersk Drilling — from expanding in Russia.

That’s some recommendation from a company that runs one of the world’s most successful transportation operations.

 Contact Bruce Barnard at brucebarnard47@hotmail.com.

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