Stockwatch: should I buy this cyclical after panic selling?

It was a first tremor. Mid-cap shares in shipping services group Clarkson (LSE:CKN) yesterday plunged 18% initially - not on surprise poor figures but gently put words in the outlook statement about how its markets are softening.

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Notably, a rebound from around 3,580p to near 3,800p did not hold – whereas in previous weeks and months, buying a hard-hit share first thing was more likely to work as a day trade or top-up investment. Clarkson’s slide continued throughout the day, with minor recoveries quashed and another 2% lost as the US market had quite an earthquake – the stock closing down nearly 22% at 3,455p. This morning, it initially ceded another 20p but has crept up to 3,470p.

The fear in Clarkson – and what later engulfed Wall Street yesterday – is heightened risk of recession, and why my piece last week examined this as Trump’s tariffs cause chaos.

Shipping obviously is among those industries on the front line, although Clarkson also noted the Middle East and Russia-Ukraine conflicts “adding complexities”, hence tempering demand.

It begs a classic question in investment: should you buy or avoid – even sell – a cyclical share that plunges at possibly the early stages of a wider downturn? The five-year chart looks respectable enough, if volatile and possibly faltering:

Source: TradingView. Past performance is not a guide to future performance.

A dilemma for Clarkson is it yielding just over 3% despite earnings cover around 2.5x – greater in terms of free cash flow – and its cash-generative profile meaning £431 million cash is its largest balance sheet item. The 109p dividend in respect of 2024 represents a 22nd year of dividend growth, achieved without interruption throughout Covid. But in terms of compensation for the risks as things get ever-more uncertain, it seems unlikely to attract income buyers.

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That said, Clarkson fits the bill as a “quality cyclical”, founded in 1852, nowadays with global reach and significantly diversified despite 80% of revenue deriving from ship broking. Since the 2008 crisis, it has risen in volatile fashion, still up seven-fold at today’s prices or nine-fold against peaks around 4,500p last July and February.

Operating margins are strong despite criticism of a bonus culture - 23% in broking, 12% in financial services also support services, and 39% in the smaller data division.

Clarkson - financial summary
Year-end 31 Dec

Source: historic company REFS and company accounts.

In due respect of such, Clarkson recently traded on forward price/earnings (PE) multiples in the mid-teens, despite expectations for only a few per cent earnings growth this year. One downgrade yesterday was to an earnings per share (EPS) fall of around 8% to 263p – implying a forward PE just over 13x, which seems fair enough.

Whether a global recession ensues (in the technical sense of two successive quarters of decline in gross domestic product), Clarkson’s now referencing “headwinds” and with Trump only just embarking on a four-year term, this could well be a sea change.

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If directors buy seriously now, it will create some bounce, however there’s no sign as yet, and I would imagine even if they recognise value, a prudent approach would be averaging-in – which is unlikely to grab attention, wise though it may be.

If there is no insider buying, that informs us that they believe it’s time to buckle down and see what happens. Such a moral likely applies more widely in cyclical shares.

Clarkson has quite often been capricious to interpret

While the aspect of downgrades is as yet modest, and consistent with Clarkson’s underlying volatility, a dilemma is it following a surprise on the upside as recently as 10 January when 2024 profit was guided slightly ahead of expectations. Common sense implies shipping as exposed in a trade war, but it has needed making plain in an update that shipping rates are now lower than 2024.

Setting the context and looking more closely: a year ago, Clarkson proclaimed a record order book a year, and although up only $1 million to $217 million on 2023, this was “for delivery in 2024 only”. Meanwhile, “our much larger forward order book which stretches further into the future, gives us growing visibility and the confidence to continue to invest...”

Such logic helps explain why the share has plunged despite a forward order book for invoicing this year up 6.5% to $231 million - it has benefited from last year’s forward book feeding the 2025 invoicing prospect. 2025 is evolving “with more uncertainty than most” the CEO says, hence a fall in freight rates.

Recent years’ experience shows how capricious shipping can be, even before the stock market “does its own thing”. I initially argued that Clarkson’s risk/reward profile tilted to “buy” at 2,700p in August 2017, when shipping markets looked to be improving and the shares offered a possible hedge against weaker sterling in the wake of Brexit. The subsequent trend was volatile-sideways but included a rally to over 4,000p by late 2021.

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In August 2023, Clarkson noted shipping rates softening quite like today, but in March 2024 its narrative had turned plenty more bullish amid favourable sector trends and global trade growing in scale and complexity. The shares rallied over 20% from 3,780p to 4,570p by end-July, but the interim results proved disappointing. The CEO cited supply-side constraints resulting in a lower order book, especially bulk-shipping and tankers. Revenue from broking was cited lower than the first half of 2023 and “second-half weighted”.

That a profit upgrade was even possible at all last January shows how to take such guidance cautiously, and how management’s renewed talk of a second-half weighted year may not imply profit warnings eventually.

2024 revenue turned out to have risen 6% to £661 million, underlying earnings per share up 4% at 287p and the dividend raised 7% to 109p. There is no debt beyond £38 million lease liabilities, hence £13 million net finance income on the cash reserve adding nearly 13% to operating profit. It should make Clarkson resilient for a “stagflation” environment, which increasingly looks the base-case scenario.

The latest share price drop therefore has more to do with the market cutting what it deems the appropriate PE – without sufficiently strong yield support to compensate.

Clarkson’s shift in underlying trading outlook might end up worse than we have seen since the 2008 crisis, if tariff threats are followed through, but as yet is hardly abnormal in shipping services.

With China, for example, vowing to “fight to the bitter end” on trade, I do, however, tilt warily on Clarkson right now. If market sentiment improves, with nations drawing in their horns on tariff threats, it can rally somewhat. But, overall, the pricing feels quite right, hence “hold”.

Focus on company trends rather than bond yields

In my last piece, I expressed skepticism about bond/equity yields as a prime factor in investment decisions. While I may have some bias as a companies’ analyst, I think such updates inform us of commercial realities, whereas financial market pricing includes expectations that could be flawed.

This time last year an inverted yield curve manifested in government bonds (greater returns in the short term instead of further out) as if a recession indicator. Yet Clarkson cited an improved outlook with its 2023 result and, in fairness, its 2024 numbers have verified this. The yield curve was flawed as an indicator.

Whether the stock or bond market, both reflect human judgement. If you need emotional support right now, an adage originally traced to economist Paul Samuelson in 1966 is how “the stock market has predicted nine out of the last five recessions”.

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