Clarkson PLC CKN
June 16, 2010 - 6:17pm EST by
dylex849
2010 2011
Price: 9.00 EPS $0.95 $1.10
Shares Out. (in M): 19 P/E 9.2x 8.1x
Market Cap (in M): 250 P/FCF 9.5x 8.2x
Net Debt (in M): 73 EBIT 36 41
TEV: 177 TEV/EBIT 4.9x 4.3x

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Description

Bottom line- single digit p/e on depressed earnings, net of cash even cheaper, 5% div yield 2x covered, toll on global GDP growth, optionality that investment services delivers.  In short, a coward's way to play an economic recovery, and already cheap if the recovery never comes.

Introduction

  • World's largest integrated shipping services business with 150 year history (you know the name if you have ever done research on a shipping investment)
  • This is a global franchise with a reputation and competitive position that is unrivaled in the industry
  • Classic brokerage business in that the larger you are the stronger your competitive position
  • Clear #1 market position in activities representing 80% of the company's revenue (gained share in 2009)
  • Valuator of choice for fundraisings performed by 21 of the world's top 25 I-banks
  • Global business with exposure to every aspect of shipping from charters to scrapping of vessels (see website at www.clarksons.com for details)
  • Leading research organization (70 people) that is world authority on all things shipping and 10x size of next largest competitor
  • Average operating margin of 18% over the past 6 years (23.6% peak, 12.8% trough)
  • Bonuses are 50% of PBT and act as natural release valve in good times and bad
  • Low capital intensity of roughly £2m per year against avg EBIT of about £25m
  • Global network of 21 offices with brokers across multiple disciplines removes risk of heavy exposure to any one individual or team
  • Almost 800 employees globally, of which about half are brokers
  • Strictly an agent and take no principal risk
  • Management owns 25% of the company.   CMB, leading shipping company, owns another 17% (not awful to have a large customer as a large shareholder)
  • EV value deducts accrued bonuses from cash in attempt to be conservative, while also dinging company for 7m pension liability
  • EV gives credit for 18mn of various hidden assets, including investment in hedge fund, stake in Baltic Exchange, conservative value on legacy shipping asset (Hermian) that is for sale

The Pitch

  • Clarksons makes money by charging a fixed commission in basis points on broking transactions
  • Transactions are determined by volumes multiplied by rates
  • Rates in 2009 were very depressed with many operators operating at cash b/e.  Volumes weren't wonderful either.
  • Rates in 2010 have recovered and longer term rates should return to a level that allow operators to earn their cost of capital
  • Toll on global GDP growth as shipping volumes expand. As one data point,  the global fleet for Dry bulk has grown tonnage by 60% from 2004 through 2010. Other disciplines have increased fleet size as well (e.g. Tankers, Containers, LNG, etc.) and it is not inconceivable that respective fleets are markedly larger five years from now. 
  • Financial segment includes I Banking and internal hedge fund that are not currently profitable
  • 2009 was a crummy year for the shipping industry and the company made £22.7m, putting the valuation at an EV of ~5x EBIT on a trailing basis for 2009 results
  • 2009 earnings were further depressed by severance to former CEO and losses in financial services division (call is 25m if you want to normalize)
  • 2010 should be better than 2009 (see interim trading statement that says "We have experienced steady improvements in the trading environment since the beginning of the year")
  • Business is less cyclical than one might suspect due to the broking business having a forward order book that generally covers 30-40% of each year's broking revenue.  Forward book actually spreads out decades (albeit small portion), but the company only discloses that portion which will be realized in the next calendar year
  • I believe good chance that order book at end of 2010 is bigger than it was going into the year
  • Hedge fund has had good numbers but lacks critical mass
  • I Bank is partnership with Johnson Rice that is embryonic
  • 2009 historical and my 2010/11 forecast figures incorporate divisional losses on Ibank and hedge fund, however valuation provides no optionality for success
  • Will shut down both of above if not at b/e within 18 months
  • FWIW CEO believes investment services could make a meaningful contribution to EBIT in the next few years
  • Stealth play on Sterling weakness as largely USD revenue and Sterling costs. In 2004-2007 the company made £20-25m with Sterling ~25% above current levels. If Sterling stays around current levels or weakens further, much of the differential will drop down to the bottom line.  Partial hedge in place for 2010, but will roll off in 2011, suggesting ceteris paribus higher earnings in 2011 vs 2010.
If interested in the name Panmure is house broker

Catalyst

High quality global franchise that fundamentally has leading market positions and attractive economics
Absolutely cheap valuation with 5% dividend yield
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    Description

    Bottom line- single digit p/e on depressed earnings, net of cash even cheaper, 5% div yield 2x covered, toll on global GDP growth, optionality that investment services delivers.  In short, a coward's way to play an economic recovery, and already cheap if the recovery never comes.

    Introduction

    The Pitch

    If interested in the name Panmure is house broker

    Catalyst

    High quality global franchise that fundamentally has leading market positions and attractive economics
    Absolutely cheap valuation with 5% dividend yield

    Messages


    SubjectRE: Margins
    Entry06/17/2010 12:39 AM
    Memberdylex849
    My numbers for broking (ignoring corp...strictly segmented profits) are as follows after making some adjustments to eliminate non cash amortization charges related to acqusitions by prior mgmnt team:
     
                2009       2008          2007      2006       2005       2004
    Rev      139.3    193.3           135.4     96.7        94.0        67.5
    EBIT       26.6      56.0             31.6     19.0         22.6       18.4
    Margin   19.1       28.9            23.3       19.6        24.0       27.3
     
    Of the above, each year expect for 2008 are historical taken directly from old annuals, with the exception of 2008 where I had to make adjustments for the amortization writedowns, which were primarily taken against the broking division.
     
    Bonus are broadly speaking 50% of Pre-tax  pre bonus profit as demonstrateed below 
     
    $100 Rev
    $60 regular costs
    $40 pre tax pre bonus profit
    $20 bonus
    $20 EBIT
     
    As discussed in writeup, bonus structure acts as compression valve in good times and bad.  In my opinion 2004/2008 margins are higher than normal (there was a different bonus structure in place in 2004) and perhaps 2009 margins are a little lower than normal.  I would suggest 2005-2007 are demonstrable normal broking margins.  Going forward my model assumes broking margins of roughly 19.3% in the base case which is based on various assumptions regarding cost inflation, fx rates and operating leverage across each broking division.
     
    If you go back to old annual you will see Futures broking had EBIT margins on average of 30%+ from 2004-2008.  These were not disclosed in 2009, but I suspect were off very sharply.  2009 financial segment (Futures not broken out post 2008) was negative, due largely to I bank and hedge fund and collapse of Futures biz.  I suspect this division will show improved profitability this year and next as Futures has begun to rebound (confirmed in discussion with Braemar) and losses at hedge fund/Ibank are pared.   For what it is worth, if you aggregate historical segments to match to the current Financial segment, you can see that the falloff in Financial margins started in 2008 due to the hedge fund and I banking investment (verifiable by publicly disclosed Futures margin of 34.2% in 2008).
     
    Research is a small division but has EBIT margins of high teens on average.  This is a small business, but high margin subscription revenue with significant growth potential.
     
    Support has several small profitable businesses whose EBIT is being offset by the Hermian.  When the Hermain is sold you should see this is a 5-10% margin business, but will remain small.
     
    As for other variable costs, largely travel and entertainment (down 23.8% in 2009 vs 2008 but actual spend in pounds is not discosed.).  Safe to assume rest of costs are largely fixed.
     
     

    SubjectRE: Multiple
    Entry06/17/2010 12:52 AM
    Memberdylex849
    There was a large lawsuit overhanging the company that came about under prior management.  This hung over the share price until settled, not to mention I believe the market considered Clarkson a show me story with respect to profitability in a down market.
     
    That said there is not much of a "street" on this name.  It is not well followed, most who cover shipping don't know it is public, and it is in general on oddball.  I have spoken to the other publicly listed broker, Braemar, which also trades at a lowly valuation.  Management teams of both companies are surprised by valuations, and in each case seem to be at minimum mildly determined to improve market awareness of the sector.
     
    As for commissions, they have been steady for at least the last 30 years with no signs of compression.  I have not learnt anything to suspect that the economics are not intact going forward.  There was an effort to take the industry to "screens" in the early part of this decade that quickly fizzled out.  I don't want to oversimplify, but getting a contract done in the shipping industry is not wildly dissimilar to selling/buying a house.  There are various one-offs that pop up and the market is somewhat opaque, such that the nature of the industry lends itself to broking by person rather than screens.
     
    As for the competitive position of Clarkson/Braemar, both have publicly stated they took market share in the downturn at the expense of smaller brokers.  So I don't believe either are structurally challenged with respect to the competitive environment.
     
    With respect to multiples, we can all have our own opinion as to what appropriate multiples are for the business...that is what makes a market.  All I know is media stocks used to get high multiples and spirits companies used to get low multiplies.  Now media get low multiples and spirits high multiples.  That said in this period I suspect the value a reasonable man would pay for a given business based on self-assessed intrinsic values moved around less than market multiples.

    SubjectRE: Cash & Options
    Entry06/17/2010 01:10 AM
    Memberdylex849
    New mgmnt joined in 2008 after the old team was tossed.  I believe a significant portion of the grant of which you speak was one time upon these individuals joining.  Historically share grants have not been 10m each year, and I don't expect them to be of that size going forward.
     
    As for cash, I optically see about 31m on the balance sheet.  I take total cash of 143 and then net off 48 of debt, 57 for accrued bonuses and 7 for the underfunded pension.
     
    The company has a progressive dividend plan as you can see from the historical track record, and I would expect future dividends to increase with profits as they have in the past.
     
    I don't believe one should mix financial leverage with operating leverage, so I would prefer the company remain ungeared.  I have spoken to management and my sense is that they fully understand that the balance sheet currently has more than sufficient cash and there is no need to further grow reserves.  I have been having a dialogue to encourage them to repurchase shares.  I did not mention this in the write-up as I do not currently have a sense as to whether I will make any headway.
     
    As for the employee trust, consider them like treasury shares until issued.
     
    If one just ignores the balance sheet the valuation is about 8-9x earnings with a 5% dividend yield on what I believe are depressed earnings from both a cyclical basis and due to losses from the financial division.  You may indeed be correct that one won't make any money at this valuation...time will tell but risk reward stikes me as less than awful. 
     
    I'll also note that CMB is a not uninformed industry player willing to take the other side of your bet.  Lastly I will note that various private equity buyers have kicked the tires in the past.  I don't think PE would pay a premium on current prices, but if stock dropped I could see a scenario where a PE sponsored MBO if nothing else gets you back to a price in the current neighborhood (e.g. a floor).

    SubjectRE: question
    Entry06/17/2010 10:02 AM
    Memberdylex849
    I am not a pension expert, but I have to think CKN's pension as compared to KO or PG is high because it is a people business.  If I crack open the Aon annual, I see the gross accumulated benefit obligation at year-end was about $8bn vs a market cap of $10bn.  If I look at WSH, benefit obligation at year-end was about $2.5bn, or a little less than 50% of the market cap.  I'm not trying to cherry pick, just select two similar businesses that have a meaningful presence in the UK.
    Rightly or wrongly, I look at the pension on a net basis.  If you follow the insurance brokers, (Aon, Willis), both will tell you that UK pension accounting is an area that is rather murky, with the actuary having significant flexibilty to determine the surplus/deficit each year (more so than in the US).  Clarkson gross liability vs market cap is about 75%, so right in the middle of the Aon/WSH, albeit CKN is the most well funded on a comparative basis with a relatively modest net liability (4% of market cap).
    I hope the above is somewhat helpful, but in conclusion I think about this in terms of the net liability.
    Thanks for the kind words with respect to the write-up.

    SubjectRE: RE: question
    Entry06/17/2010 11:10 AM
    Membercoffee1029
    Thanks for your thoughts.

    SubjectRE: Thanks
    Entry06/17/2010 08:01 PM
    Memberdylex849
    Yes I would like to try get them to do a buyback, but as I said I don't know if I'll get them there.  In my mind I get a 5% yield while I try and fight the good fight to convince them otherwise.  While payout ratio is still only 50%, it is worth noting they have been increasing the dividend every year as of late, even during 2009 when profitability was down.
     
    CEO/CFO have told me they don't intend to further build cash reserves.  CFO told me they compare acquisitions to buybacks, but think they can add more value via acquisitions, though like you I don't necessarily believe that is the truth.  That said acquisitions with new mgmnt team have been immaterial (actually I can't think of any of top of my head), and really just adding people and teams (such as beefing up containers).
     
    I think they will likely use part of the cash to payoff the oustanding debt, and part should be thought of as earmarked for accrued dividends (which is why I back them out of my EV).  In my eyes this ends up putting EV at about 6.5x earnings, but this gives credit for hidden assets such as the Hermain and Baltic.  For what it is worth they have already sold off 2/3 shipping assets inherited from prior mgmnt team, so not as though they have their feet stuck in the mud.  They fully intend to sell Hermian as soon as they can get a decent price, though I can't predict when this will be.
     
    I honestly don't know which fivolous uses of cash you are referring to, so happy to have you share if you want to spend time responding (but freel free to ignore if you feel like you've wasted enough time already on the name).   I will note that the mgmnt team beefed up the offshore team last year which would have been a cash usage, but from what I undestand they are already seeing the benefits of that spend in 2010.  On the income statement they reigned in expenses in 2009 by cutting T&E and closing/amalgamating some branches that were sub critical mass.
     
    In conclusion I would prefer if mgmnt would buyback stock, but I'd rate them more of average than 1 (but I'm not saying they are rockstars).  This would all change however if they ever cut the diviend, in which case I'd argue they would deserve much more than a puppy slap on the nose.
     
    Again no need to respond, just illustrating how I see things.

    Subject1H Results
    Entry08/25/2010 09:50 AM
    Memberdylex849
    Just in case anybody is following (and this will be my last post unless I hear otherwise),  the investment thesis that 2010 will be a better year than 2009 is holding true.   Results are out today and 1H PBT is up 49% year over year and the dividend was raised slightly (likely to be about a 5% dividend yield at today's price).

    SubjectUpdate
    Entry11/28/2011 12:16 PM
    Memberef901
    Hi Dylex, I was curious to hear your current thoughts on this name? I thinks the valuation still looks interesting. One large concern for me is the situation in the tanker (and broader) shipping market which doesn't look like it will be rectified anytime soon... 
     
    thanks in advance.
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