Sailing into the future with Clarksons

A question of trust

Judging by the stats, Clarksons is a no-brainer. But to add this company to the Thrifty 30 portfolio I must overcome two massive prejudices of mine. Maybe I’ll fail, but I refuse to give in to prejudice without at least contemplating it.

First the stats. Look at this:

Without looking behind the numbers, Clarksons has been a highly profitable business over the last ten years with a strong balance sheet. Statistically it’s Nifty, and not that expensive. The earnings yield implied by a price to book value of 1.7 is 16% and the company hasn’t given investors any reason to believe business is about to deteriorate markedly.

Clarksons claims to be the world’s leading supplier of shipping services, which must make it the world’s leading shipbroker. Eighty-two per-cent of its revenues in 2010 came from deals it negotiated to transport cargo or buy and sell ships. The rest was earned from various services, some traditional, like stevedoring (loading and unloading ships), and others more modern. By publishing research, and advising on corporate deals it operates as a small investment bank specialised in shipping.

Its position in the statistical sweet spot and the durability implied by its 150 year history are attractive, but despite its romantic past it remains a financial institution.

I don’t trust financial institutions for two reasons (I’m generalising, that’s prejudice for you).

The first is complexity. I couldn’t make sense of an investment bank’s balance sheet, and the fact that so few people can, including some of the people that run these institutions, goes some way to explaining the current financial crisis. Clarksons’ investment banking operations are relatively small though, and broking should be a straightforward business. You provide a service, and charge a fee, so maybe there’s no need to worry.

The second reason is money. Another lesson of the financial crisis is how skilled the people who ran certain financial institutions were at creating wealth for themselves, at the expense of shareholders and ultimately the taxpayer. Peter Mandelson was intensely relaxed about people getting filthy rich, but the collateral damage caused by financiers getting filthy reach makes his attitude seem a little naive now.

£550,000 is a generous annual salary for a Thrifty 30 executive but Clarksons is probably larger than average, so I won’t quibble about chief executive (right) Andi Case’s basic pay.

I’m nervous about the £4.4m bonus he received in 2010 though.

The company explains its bonuses should not encourage excessive risk-taking because basic salaries are sufficient to cover living expenses and the performance measures are robust and objective. They’re based on the overall profit of the company, and limited by the remuneration committee to ensure an ‘appropriate’ split with shareholders.

There was plenty of profit to go around in 2010. Together the executive directors earned bonuses worth about £6m compared to £23.5m in net profit for shareholders in 2010 but I question the extent to which the bonus rewards skill. Largely, the profits of a brokerage must depend on how much shipping takes place, which is a factor of the global economy over which executives have no control.

I’d feel more comfortable if the directors were also major shareholders. Case owns the most, 550,000 shares, worth about £5m. It sounds a lot, but it is only a year’s pay. If profits were to decline, would the company scale bonuses down in line with profits? Or would shareholders take most of the pain as the board argues it needs to retain key members?

And here’s my other prejudice. I’m not confident there will always be enough profit to go around. Like the commodities the ships Clarksons charters move around the globe, the company has enjoyed a period of booming international trade dependent on European and North American consumption and Chinese production, both of which look fragile.

Generally, I don’t put much faith in stories about the economy, or at least I let the numbers and stories about a company trump them, but some economic stories are so big and obvious they’re difficult to ignore.

I’m hoping Calum, aka Valuehunteruk, will respond to this blog because he’s written about Clarksons favourably. Next I’m going to compare Braemar Shipping Services and see what more I can learn about shipbroking.

10 Comments

John @ UKValueInvestor.com November 14, 2011 at 1:01 pm

Both those companies look very cheap, but…. shipping is a very cyclical business it seems. I own Braemar, partly because it ticked my boxes and partly because it is more diversified than Clarkson (about 60% revenue from shipbroking if memory serves), but I’ve limited myself to one shipbroker so that if it all goes on a long down-trend my exposure is less.

You might want to skim through this at bedtime:

http://www.clarksons.net/archive/research/freestuff/RINA%20President's%20Invitation%20Lecture%2011%20Nov%202009.pdf

Reply
- Richard Beddard November 14, 2011 at 1:30 pm
  
  Hi John,
  
  Thanks for the link, it looks like a must read.
  
  I’m just looking at Braemar now, and by revenue it is much more diversified (about 50% in Feb 2011 came from Shipbroking I think).
  
  Look at operating profit though, and almost all of it comes from shipbroking. The other three divisions had operating margins of just 3% compared to 22% for shipbroking.
  
  So I’m not sure how much protection diversification gives investors. Especially as shipping services, like broking, are dependent on the same cycles and supercycles you’ve brought to my attention (presumably!).
  
  Another way of looking at Braemar is as a second rate Claksons with a bunch of underperforming businesses attached!
  
  I may be doing them an injustice, though. Some were only bought recently out of administration so perhaps they have great recovery potential. A third way of looking at Braemar.
  
  Not sure yet, which version of reality I ascribe the highest probability too
  
  Sorry for the stream of consciousness, but if you catch me in the middle of looking at a company you’ll get confusion!
  
  Reply
- LOLTradez November 15, 2011 at 8:26 pm
  
  That Stopford report is depressing!
  
  ~3.75/share in cash, great fcf and market position but the wrong side of a decades-long shipping cycle. All of the sudden I’m losing faith.
  
  Reply
  - Richard Beddard November 16, 2011 at 12:29 pm
    
    Hi LOLTradez.
    
    The case for a prolong down-cycle seems compelling. Stopford describes the mechanism of over supply (triggered by increased demand due to Chinese growth), and demand shock (the financial crisis, and economic crisis in Europe/USA) extremely well.
    
    The question is how sensitive is Clarksons to the shipping cycle? Certainly the share price performed very well in the 2000′s which coincides with the shipping bubble he describes and was flat before that back to ’94, which is as far as I can see
    
    As for profits I just don’t have the data going back far enough to see how the company performs during a down-cycle.
    
    As Calum says, it’s a broker so it’s more dependent on international trade than the state of the market for ships, which is more critical for shipowners and shipbuilders. Even in the terrible 1980′s shipping trade increased 1% pa so maybe the adjustment brokers are making is from high growth to stagnant growth. Clarksons could still profit in the doldrums, and make investors a good return.
    
    All of that’s predicated on continued globalisation though, albeit at reduced level until the global economic problems are resolved. If we went through a period of protectionism etc. then the whole thesis unravels and we have to look to the colonial period before the second world war for parallels.
    
    That’s quite a backdrop to an investment!
    
    Reply
    - Calum November 16, 2011 at 5:39 pm
      
      One interesting idea I had recently in terms of protectionism is a sort of reversal of the 1970s when oil began being traded on the spot market. So when it was just traded by the Big 6 oil companies they owned all their ships wheras now the main competitive balance is cash flows between ship-owners and charterers. I don’t know much about natural resources but it was nationalism/expropriation that brought oil onto the spot market so a possibility is that we see this trend again as resource rich countries take back their resources again and do all the marketing and distribution themselves.
      
      Reply
Calum November 14, 2011 at 2:14 pm

I don’t think I can add too much here tbh. The only asset the company has is the people so pay is always going to be problem. I think CKN probably has a bit of “brand” value built up through its research and the advantage is always with the person who can see the most flow and provide the widest service. I wouldn’t say the business is too cycical (relative to owners of ships) either as it does newbuild deals and makes a spread in trading so it is volume rather than price.

I agree about the general shipping market looking weak though and, as far as I know, there are still queues for new builds. It seems to me that, as with cars, the main issue is scrapping (martin stopford, a director of CKN has a book about shipping as well which talks about this). When rates go up, old ships have the largest increases in value, when they go down, they have the largest decreases. It is a case of hitting bottom, people going bust and the marginal ships going to scrap. It is difficult to tell what is actually going on as the world economy has been pushed to extremes but I think there is more to come (maybe a trade slowdown, maybe an interest rate spike). Either way, CKN will probablly be fine (it has gone through worse) and the cycles will continue. Investing requires buying into the “story” though as there are no “real” assets…at an earnings yield of over 10% I don’t think buying in is too difficult.

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- Richard Beddard November 14, 2011 at 4:10 pm
  
  Thanks Calum.
  
  Reply
Duncan November 16, 2011 at 10:25 pm

Hi,

Great blog – I really enjoy some of the content. You should find a way to allow people to subscribe by email as I always miss posts.

I’ve discussed the shipbrokers with Calum before if memory serves me correctly. The fact is that they screen really well and they have a good history of building shareholder value. However, if you believe in a 2012 recession and you should…..

http://kelpie-capital.com/2011/10/18/recessionary-times-the-evidence-is-compelling/

I can’t see how macro fears and sentiment don’t take these stocks down much further from here.

I had a chat with one industry insider whom I happened to know and he downplayed the role of the brand equity that Calum talked about with Clarkson. It is a hugely fragmented industry and he reckoned that it was a relationship business where customers will follow brokers to new firms as long as they can still be serviced effectively. In that sense, it seems quite similar to an inter broker dealer or a private bank/stockbroker where the employees have far more control than they deserve and therefore get paid disproportionately.

I also had a brief exchange with the FD of BMS and he expressed that they didn’t have any plans to use buybacks (nor have they ever if I remember correctly) which is a shame as this would be one easy way to punish the market for it’s misunderstanding of the robustness of the businsesses, if not the robustness of the earnings.

Having said all this, I think I’d probably buy BMS at < 300p.

Reply
- Richard Beddard November 17, 2011 at 10:10 am
  
  Thanks Duncan,
  
  I used to have a subscribe by email function but it kept breaking so I dropped it. You can follow by rss: http://blog.iii.co.uk/feed/ twitter: https://twitter.com/#!/RichardBeddard and facebook: http://www.facebook.com/richard.beddard2 . On Twitter I also comment and link to other blogs/sites (the facebook updates are identical).
  
  I follow your blog by rss
  
  Interesting insights. My position has evolved a bit having looked at Braemar ( http://blog.iii.co.uk/the-meaning-of-braemars-diversification/). I too am not inclined to take Clarksons superiority for granted and find Braemar the more interesting proposition. If a company maintains its market position by overpaying its staff it seems unlikely to work out well for shareholders in the long run. Although it worked out well in the go-go naughties if revenues come under pressure due to the state of the world economy and the shipping cycle that could change. Clarksons thinks of itself as comparable to City institution, but it seems to me they’re all trapped in a remuneration arms race which makes them risky businesses and investments.
  
  Reply
Kazumi Ikeya November 21, 2011 at 8:56 am

Thanks for the insights and especially the stats . l have followed the shipping industry for many years and have always thought that shipowners could make more moolah by trading shipping shares than by running a shipowning business .
Be that as it may , the bulkers always appear to have the greatest run up from a bottom , so Goldenport and Hellenic appear to be about ripe for plucking right now if indeed a bottom has been reached .
Kazumi .

P.S. The Greek owners appear to have the best survival rate .
l do not own the two stocks mentioned .

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