Stockwatch: A share to buy amid China woes

Is the plunging stock for shipping services group Clarksons overdoing its fall, or a prime example of risks to market valuations as deflation bites? In recent days the Mid 250-listed shares have continued to plunge from a 2,800p peak surrounding interim results, currently about 2,280p.

I was curious how Clarksons had risen to a 12-month forward price/earnings (PE) in the high teens against a prospective yield only of about 2.5%, given shipping is inherently cyclical and various economic warning signs flash. Literally in the last day or so, the price has slumped - as if affirming this gut feel - in a chart context of a roller coaster during the previous year.

The medium-term context shows a strong rally from £1,175p in early 2013, then a sell-off from 2,740p to 1,875p in 2014 - a pattern we have seen in many cyclical stocks. Monetary stimulus prompted investors to embrace risk in 2013, with cyclicals becoming a momentum trade, then 2014 saw a reality check and self-reinforcing bias switching to the downside. Quite like commodity-related stocks, Clarksons is caught in a dilemma whether deflation will intensify or the commodities sell-off is overdone amid excess fears for China.

Plunge in freight shipping rates

Exacerbating such concerns has been freight rates for container shipping from Asia to Europe, suddenly down by over 20% - at a time when trade volumes should be picking up. In the US, a New York state manufacturing index has slumped with new shipments and orders down about 15% - i.e. a read-across to the shipping industry. Coinciding with China letting its currency drop, such news is likely the chief reason for Clarksons' shares falling, in a context where management says the annual results will be second-half weighted. It's a classic jolt to expectations that sends the market probing for a new support level.

Platou acquisition blurs the underlying trend

While the 17 August interim results appear very good, they enjoy a five-month contribution from RS Platou ASA, a Norwegian acquisition initiated in November 2014 and completed last February. This together with strong performance from tanker-broking, also specialised products and gas markets, helped pre-tax profit soar 49% to £23.6 million on revenue up 30% to £145.3 million. Yet earnings per share dropped nearly 13% to 54.3p, implying a share issue: last November Clarksons' share capital was enlarged 8.5% by aplacing at 1,950p to help finance the £281.2 million acquisition of Platou - the sector's biggest takeover deal.

This could be interpreted as a means to buttress earning power in a cyclical industry, although management has made a case for synergies - the two businesses sharing geographic locations, operations and industry specialisation. Clarksons' historic profile has been predominantly shipbroking, also support services, finance and research - and Platou enhances all this.

While raising exposure to the oil & gas industry appears risky at a time of an oil glut, and first-half performance in the offshore (oil industry) segment cited falling utilisation and increasing availability as vessels come off existing contracts, low oil prices also mean strong global oil demand. Tankers have had an "extremely positive" first half, irrespective of market sector. "Whether vessels are being traded in the crude oil or the clean/dirty refined products market, owners have seen significant increases in their daily earnings." So don't assume the plunge in oil prices is necessarily a negative.

Trend in international trade is the more likely key

Management professes its "full service client offer across shipping and offshore, broking and banking, is truly unique" and Platou enhances Clarksons' leadership. There's quite a spread of activities which makes sense to diversify against sector-specific volatility; but all-considered the group and its shares are a litmus test for global trade. This is why a near 18% drop in the shares is pertinent for investors generally - as if a wider inflection point, the market reacting to risks of a ripple-effect from China's slowdown. Since China has been a very significant support to the global economy since the 2008 financial crisis, besides monetary stimulus, then if she is slowing just as Western central bankers are looking to normalise monetary policy with an interest rate rise, it implies a potential slowdown in international trade.

Also, in a five-year context Clarksons' PE multiple has got relatively high - so is exposed to any sentiment change. Company REFS shows the annual average PE rising from 8-9 times during 2011/12, into a mid-20's range during 2013/14 as investors bought riskier cyclicals; then a sell-off as traders doubted such ratings were durable. 2015 has seen a rebound but similar doubts have struck again.

In the circumstances, Clarksons' prospective yield of about 2.5% is no real prop. Expectations for about £62 million pre-tax profit for 2015 may still hold, but the market is questioning the earnings rating. The chief executive concedes, the business is "multi-cyclical and volatile" - hardly as if a PE in the high teens is appropriate. The market is being rational to probe for a support level, possibly somewhere in the PE mid-teens which recognises Clarksons' leadership and commercial strengths - but also current risks of further bad news on freight rates and economies generally.

Money supply figures constitute hope

Possibly the key upside factor is tacit signs of rising money supply in a number of countries, fore-shadowing greater economic activity say six months hence - which would be reflected in international trade and shipping. On this basis the stock is worth watching if still quite pricey overall, especially if further bad news emanates from China. The chart is presently a falling knife and there is no margin of safety beyond a sense of the business as an industry leader. So take care while being aware, this is a stock to buy when sentiment is against it.

For more information see: clarksons.com.