Stockwatch: much risk is priced in, but is it time to buy?

Despite strong numbers from Clarkson (LSE:CKN), a FTSE 250 shipping services group, its interim results contained elements of caution. In response, its stock has fallen around 5% to 2,730p.  

I keep an eye on demand for shipping as a reflection of global economic activity, of what lies ahead – a key question being, what is the possible delayed effect of higher interest rates? 

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Normalised operating profit is up 16% at near £50 million on revenue up 20% to £321 million, implying a strong margin near 16%. Net profit is up 26% near £42 million and, with full-year expectations affirmed, the forward price/earnings (PE) multiple is around 12 times and the dividend yield 3.5%.  

It does not exactly scream value but in chart terms the stock has mean-reverted nearly 30% from 3,900p in November 2021, back to a steadily upward trendline since the 2008 financial crisis. That is notable for a quality – admittedly cyclical – stock. Clarkson is the leading global provider of integrated shipping services and in its 21st consecutive year of raising the dividend. 

Energy demand offsets weaker elements of shipping 

The CEO cites “generally positive” conditions during the first half, with vessel freight earnings above the 10-year average. Yet this was driven by energy-related markets while softer conditions prevailed in the container and dry bulk market. Global oil demand is expected to strengthen in the second half of this year, and through 2024. 

Among reasons I think inflation will remain sticky is the follow-through on energy prices from this demand, unless supply increases commensurately. Have you noticed fuel pump prices – a key element of core inflation – jumping in recent days? 

The numbers he declares “outstanding...which reflects continued momentum in the business and effective execution of our strategy...”  

Investors appear to have latched onto the chairman’s more forward-looking remark. He says: “in an uncertain geo-political and global macroeconomic environment, we are now starting to see a softening of rates in some sectors...”  

That is to be expected from a minimum six- to 12-month lag from tighter monetary policy, but how much worse does it get? 

Clarkson derives 80% or so of revenue and profit from shipbroking, the remainder a mix of finance, support services, research and (increasingly) helping customers meet green regulations. It will always reflect demand for commodities and goods. 

Is hope for China to prop global economy a misnomer? 

Under the “dry cargo” aspect of broking, in Clarkson’s business review, management expects China’s re-opening from Covid to help ensure annualised growth in trade volumes. After contracting marginally in 2022, overall global trade has reverted to growth. 

Yet George Magnus – retired chief economist at UBS, nowadays an independent commentator and China specialist – wrote only last weekend that China’s resurgence is liable to stall because its private investment is in the doldrums.  

It fell for the first time since 2005 during the first half of this year, and private sector confidence is low. China needs to raise household consumption as a share of GDP for a better-balanced and sustainable economy; otherwise, it is looking at growth of 2% to 3% in years ahead. Yet nothing policy-wise is being done to raise household income or improve consumption. 

Magnus appears vindicated by today’s trade data on China – showing its imports fell 12% year-on-year in July, worse than the 5% expected; exports likewise, fell by nearly 15% after 12% in June. This puts in doubt China’s ability to keep global trade on a firm path.    

“An extremely limited order book” ironically supports tankers 

It is a contorted argument that management presents. The year kicked off very strongly in tanker broking, as trading patterns changed due to the Ukraine conflict, also China’s re-opening – with an average tanker earnings index up 79%. But the message now is, “an extremely limited order-book, potential seasonal support for oil in the fourth quarter, plus a further reduction in tanker new-building” implies attractive demand/supply. 

The chemical tanker fleet - serving diverse sectors from manufacturing to agriculture – similarly started the year well, but by end-June marked a 22% year-on-year decline. This is still said to leave the sector index “above levels seen in the 2008 boom.” 

But the dry cargo earnings index is down 56% year-on-year and is 14% below the 10-year average. The order book is close to record lows of just 7% of fleet capacity, which is stark.  

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In containers, first-quarter volumes were down 7% year-on-year, but by the second quarter volumes began to see improvements “though some key trades remained very weak”. Continued pressures are expected in the second half of this year.  

Elsewhere in the group, finance has seen flat performance as lower profit from real estate project finance offset growth in shipping finance. It made £5 million interim profit on £28 million revenue. Support services enjoyed a 70% profit advance, if only to just over £3 million. Research edged up profit to near £4 million on £10 million revenue. There is also a “green” team aiding customers’ transition to new regulations – for example 44% of new-build ships in the first-half-year being alternate-fuelled – if apparently small in context, as not quantified. 

A mere 1p rise in interim dividend affirms uncertainty 

In fairness, a conservative approach has ensured two decades of dividend growth. Yet the scant rise to 30p per share – despite 4.5 times earnings cover – does not exactly endorse the board’s expectations for the year as “unchanged, with continued confidence in the medium-term outlook”.  

Consensus forecasts are already cautious: for a circa 5% slip in net profit/earnings per share (EPS) this year, and another 2% easier in 2024. But dividend growth expectations – from 93p per share last year to over 100p in 2024 – look assured by a £276 million cash balance. Over 100p would cost around £31 million a year. 

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Yet proclamations of a highly cash-generative business model are not supported lately. Interim operational cash flow was negative to the tune of £20 million negative – if wholly due to a £54 million “decrease in bonus accrual” that is due a note of explanation.  

On the investing side of the cash flow statement, less than £5 million was spent on acquisitions and there was an £8 million cash transfer to current investments such as government bonds). With the final dividend greater than the interim payout, £19 million went out thus, and £39 million was spent on shares for an employee trusts. 

Should tougher times manifest, there is no debt beyond £45 million leases, hence the very strong cash position made for £3 million interim net income. 

Elsewhere on the balance sheet, short-term trade payables jumped 25% to £246 million - or as a percentage of revenue, from 73% to 77%. My basing this on interim rather than annual revenue exaggerates the percentage, although I do question if running up trade payables has boosted profit. 

Mixed picture implies edginess on the global economy 

I find Clarkson intriguing chiefly for its macro insights, notwithstanding respectable margins and a return on capital that approached 22% last year. It is challenging to share management’s confidence in the medium-term outlook. Last month, Fidelity sold around 1% of the issued equity to hold just under 5%. 

Today’s trade data from China, plus resurging fuel prices, imply the stagflation dragon is yet to be banished. A PE of around 12 times prices in much of the risk on a quality cyclical stock yet buying may be premature. Hold. 

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.