26
Feb
2017

Shipbroking and bunkering

After my last blog post, about owning shares in ports (Oceans Wilsons) and shipbroking (Braemar) a friend * set me a puzzle. Why had Clarkson (also a shipbroking business) done so much better than Braemar? That is, it can’t just be the sector they are in, because they are in the same sector: they are both shipbrokers. They are intermediaries, who arrange deals between shipowners, and charterers, who use the vessels to transport stuff around the world.  What is more, these aren’t technology companies, earning high returns by using the internet to disrupt traditional businesses.  They are not Amazon or Google, these shipbrokers have been doing this for many decades.
Is there anything obvious, to explain why Clarkson share price went from £1 a share to £24 a share today (Feb 2017)? But over the same time period Braemar share price today is exactly the same price that it was in the middle of 1998.

Doing the same thing, but one business has done 24x better than the other

Two companies, doing the same thing, but one has done 24x better than the other. What has Clarkson done right, and Braemar done wrong?
I’m not an expert on shipbroking. I just though it would be fun to go back and read the Annual Reports (the text, not the numbers) and see what they say. Some people like trainspotting. I like “baggerspotting”.

I started reading both companies Annual Reports from 1999 up until the Financial Crisis. Over this time period Braemar share price double, not bad, but taking 10 years to double your money is not my kind of investment. Clarkson on the other hand, did much better. Going from £1 a share to £10 a share in August 2008 (a ten bagger!)….ALTHOUGH I should note that in the following six months the share price crashed back to £3.50 a share. If you like “baggers” then you’ve got to love this kind of volatility, or at least make it your friend.  Because that was an opportunity, the Clarkson share price recovered. In fact, it didn’t just recover, the shares are now at £24 a share…
My first thought was perhaps Clarkson had grown turnover more successfully, and perhaps there was something in the text to suggest this. But I was wrong on both counts.

Lower turnover growth is more valuable

From 1998 to Feb 2008, Braemar actually had a higher top line growth rate (+30% Compound Annual Growth Rate) than Clarkson (+22% CAGR). However, the bottom line (pre tax profit) told a different story. The situation reversed, Braemar only grew profits (+18% CAGR) whereas Clarkson profits were up (+45% CAGR) to the end of 2007.

Clarkson 1998 2007 CAGR
Revenue 28.4 173.4 22%
Profit 1.1 31.6 45%
Margin 4% 18%

Or put another way Clarkson’s pretax profit margin increased from 4% to 18%. Braemar’s went into reverse.  Turnover is vanity.  Profit is sanity.

 

Braemar 1998 Feb 08 CAGR
Revenue 9.5 101.0 30%
Profit 3.22 14.7 18%
Margin 34% 15%

This explains the share price performance. But was there any explanation in the text why this happened? Were there any clues in the text that Clarkson’s margin would improve, and Braemar’s would deteriorate?

What went wrong?  

Let’s start with what wrong with Braemar. After the event Braemar explain in 2008 that they have deliberately shifted to lower margin activities.

The reduction is mainly due to the increased relative contributions of the non-broking businesses which generate returns at lower margins but which are less volatile.

And the facts bear this out. In 2007, both companies reported the same pre tax margin in shipbroking (22%) but at Braemar shipbroking had now fallen to less than 40% of turnover. Instead the company has diversified into logistic which makes less than 4% margin, and something called “bunker trading”, which is a third of turnover, but barely makes any profit at all.

Avoid the bunkers

Bunker trading, the company explains,

is undertaken from Australia and involves the purchase of bunkers from oil companies against matched sales to ship owners or operators.

That was the explanation.  But did Braemar saying anything before this happened?  Numbers are backward looking, but the text explaining the strategy should be forward looking.

Management in the original company that became Braemar did explain in 1999 that :

As the year progressed, it became apparent that all sectors of the shipping markets were going to continue to suffer from weak freight rates in the short term and brokerage commissions would be similarly affected. In fact our exposure was eased to some extent by long-term charter income and the delivery of newbuildings. However, it did again remind us of the need to further expand our activities into non-cyclical marine services business.
That doesn’t sound good. Management decided to diversify away from their core business. I suppose it would be expecting too much, for management to spell out clearly the negative implications of their strategy. But “reading between the lines” – that sounds very negative, even if they don’t spell it out. 
For instance, I would be skeptical of management who claim that they are in a cyclical industry, who don’t tell investors things are recovering, when their competitors (like Clarkson) do see a recovery. That is a poor investment case to make to your investors, it suggests something else is wrong.

Braemar management say that they are not going to wait for things to recover. Instead they are going to buy other businesses that they think are not cyclical. Again that’s not an attractive investment case.  

As an investor I want the maximum exposure to the recovery. Plus as an investor, I can own shares in companies with different business cycles – most managements I wouldn’t trust to do a better job than me.  That’s not because I think I’m great.  It’s because most people running companies are terrible at making acquisitions at the wrong point in the business cycle.  Think both Fred Goodwin AND John Varley fighting it out for ABN Amro in 2007.

So in retrospect there was a “sell signal” in the text, but it was not obvious. But if investing was about interpreting the obvious, then people with economics degrees would be good at it. Which mostly they aren’t.

What went right?

What did Clarkson tell their investors? Were there any clues how well they would do?
WITH ALL THE shipping markets in which we operate enjoying recovery, freight rates look set to firm in 2000. We are in a good position to take advantage of this upturn, given our concentration over the last two years on maintaining our critical mass in key markets and developing value added services.
That is exactly what I’m looking for! The shipping markets have been in the doldrums for a long time, but the company is in a good position to take advantage of the upturn. The company is also looking at value added services and extending their relationship with customers – ie they are thinking about what else they can do, that their customers will reward them for and which will deliver a high profit margin. There is no certainty that Clarkson will increase in value 24x over the next 20 years.  No one should publish a precise 12 month “target price” on the signal in the text. But the weak signal is hugely valuable nonetheless.  

The good fortune of some very difficult years 

To return to my original question about how can a traditional business, that has been around for decades become a “24 bagger.”  I think the answer lies in the text too.  Right at the front of the Annual Report, in the “Review of Operations”, where management tell us:

THE DRY CARGO sector experienced another very difficult year.  Average vessel earnings for much of the year were weaker than in 1998, a year which itself saw returns fall to the lowest level since the mid 1980’s.  An upturn in the global economy from the middle of the year however, led to a sudden increase in rates from the third quarter onwards….Whilst this recovery is a cause for optimism, it came too late to impact significantly on the results for 1999.  The full effect of this change in our earnings will be felt in the coming year.

So, conditions have been bad since the mid 1980’s, but there is specific evidence the company can point to that this has now changed.  Some cycles are not two or three years, but 15-20 years. It’s the old Fred Nietzsche “If it doesn’t kill me, it makes me stronger”, recently re-popularised by NN Taleb as “Antifragility”.  

Braemar reduced their exposure to shipbroking at exactly the wrong time, and went into less volatile but far less attractive businesses.  Taleb would have told them that volatility is only bad if management are “fragile”.  Instead I like to make volatility my friend. Management should invest in businesses that are likely to create the maximum return – and not worry about volatility.  The volatility is a challenge, there is a reason why any intermediary business like shipbroking should be higher return than something else that is steady and reliable.

So a good hunting ground for baggers may well be companies that indicators are at decade lows and having “difficult years.” These phrases could turn out to be valuable signals in the text, not in the numbers…particularly if the company can point to specifics that show the bad times are coming to an end.  

Globalisation drove an improvement in the economics of shipbroking, to the benefit of Clarkson shareholders.  The economics of another kind of broking: stockbroking, has been in decline since the late 1990’s.  There are good reasons why stockbroking might never recover, but I now know what to look for, just in case I’m wrong.

*Thanks to Andrew Latto for posing the question

2 Responses

    1. Bruce Packard

      You could be right. Maybe Braemar is now “good value” on 0.5x EV/Sales. …maybe it goes to 0.7x EV/Sales.

      BUT I’m a trying to get away from simple valuation metrics like this. Because I believe the big money to be made is in the qualitative reading of management commentary. Are management signalling in their Annual Report that they are now following a better strategy?

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