Braemar Shipping Services — Update 25 October 2016

Braemar is a broadly based international shipping services group. The largest source of income is shipbroking, where the group has a strong position in deep sea oil tankers and the offshore sectors, with principal offices in the UK, Singapore and Australia, supported by a number of other strategically placed overseas offices. The group’s non-broking businesses offer a range of technical and logistics services from offices across the UK and several overseas locations, especially in the Asia Pacific region. Technical services include specialist marine surveys involving site supervision, marine engineering, incident response and adjustment work for the insurance industry. Logistics work ranges from ship agency to freight forwarding.

The Braemar share price has fallen by 28% since publication of our Outlook report in May, This reflects the tough trading climate for both shipbroking and the oil & gas sector, as shown in the group’s trading update issued in late August, which led to sharp reductions in market estimates. Braemar’s prospective P/E rating is 28% below that of Clarkson (global shipbroking market leader) on the basis of prospective CY16 earnings (14.1x vs 19.6x). It is also rated at a discount to each of the other members of its peer group. We believe that this discount reflects market fears about the strength of the tanker market and the timing of recovery in oil exploration. The main support for the shares remains the strong balance sheet and high dividend yield. While management will, naturally, make no forecast about future dividends, the maintained interim and the prospect that it will be covered by consensus FY18 estimates, suggests to us that the payment will be held.

Shipbroking profits are sensitive to movements in spot freight rates and the £/US$ exchange rate. Volatile shipping rates will lead to fluctuating gross margins, although with a relatively high proportion of employee remuneration linked to income generated, the impact is lessened. Similarly, with considerable revenues generated in US$ and the cost base largely in sterling, the business is a beneficiary when the dollar strengthens, and vice versa. There is also a potential vulnerability to the loss of key personnel, who manage the group’s relationships with the oil majors, charterers and leading ship owners. Braemar has countered the vagaries of the shipping cycle by acquisition, introducing internationally based businesses, where income tends to reflect the volume of shipping movements and offshore oil and gas work.

Braemar has been adversely affected by very challenging trading conditions during the six months to August 2016. Group revenue came back by 12% to £70.2m, with adjusted PBT falling by more than 50% from £6.96m to £3.01m, reflecting the cautious pre-close trading statement issued in late August. There were reduced returns from all three divisions; Technical was severely affected by the reaction of large parts of its customer base to the weak oil price and slipped into losses; Shipbroking saw an inevitable profits reduction as the tanker market predictably rebounded from the heady levels of business seen last year; in Logistics a sound performance from port services was just overshadowed by disappointing freight forwarding returns.

Exceptional debits were down from £1.8m to £1.1m, again mostly related to 2014 merger with ACM Shipping. In addition, the group absorbed £1.8m of one-off restructuring costs (£1.5m Technical division; £0.3m Shipbroking division), which we have added back in the table below and to calculate our adjusted earnings estimates for the current year. After allowing for 24.5% tax on this adjustment, interim EPS emerge at 8.5p, almost covering the unchanged interim dividend of 9.0p.

Shipbroking revenues slipped back by 8% to £30.8m over the half year, entirely the result of lower shipping rates; the group actually increased the number of shipping movements managed. The reduction in adjusted operating profits was kept to just 6%, from £4.6m to £4.3m, because of the previous year’s restructuring, which sharply reduced the cost base. However, as indicated above, there were one-off restructuring costs of £0.3m in the dry cargo section, leaving declared operating profits down to £4.0m.

In the key deep-sea tanker market (est 60% of divisional revenues) there was a softening of spot rates in Q2 reflecting a combination new tonnage coming on to the market and an easing of port congestion, which adjusted the supply/demand equation. We understand that rates have recovered in recent weeks, but it is too early to assess whether the improvement is sustainable. However, as we indicated a year ago, the increased uncertainty in markets has led to a shift in the market, with key operators tending to require higher levels of support from the brokers with recognised specialist research capabilities. As a leading player in this segment of the market, Braemar believes it has at least sustained its high market share.

Similarly, the offshore market remains subdued, with exploration activity having fallen away as the oil price collapsed and, to date, shows little sign of recovery. Exploration budgets have been cut back, with spot rates weakening with the drop in demand. Braemar’s performance may have been cushioned, to a certain extent, by the continued demand for supply vessels and from a number of time charters, but another disappointing result appears inevitable in H2.

Conditions in the dry bulk cargo market have also been challenging. Despite the accelerated scrapping of older vessels, shipping capacity has stubbornly remained too high at a time when demand, especially from China, continues to fall below earlier expectations. Braemar has undertaken a restructuring in this sector, especially in Australia where the group may have been overstaffed following the ACM merger. By contrast, it has increased its exposure to the capsize sector, taking on a small, but experienced team. With spot rates tending higher in recent weeks and the reduced cost base, we are hoping for a much improved H2 in this segment of the market.

The sale and purchase operation has seen sustained income, with increased second hand and demolition activity transacted at lower average prices. We look for similar trading during the second half of the year. We still remain confident about the medium to long term – the merging of the former ACM projects desk with the Braemar sale & purchase team has led to a number of new business prospects, although many of these are subject to delay in the current shipping climate.

The drop in the oil price and its impact on exploration activity had a serious adverse effect across the Technical division. The offshore and engineering businesses both saw major trading reverses. Divisional revenue fell by 24% from £28.6m to £21.7m, while last year’s operating profit of £3.1m fell to a loss of £0.5m, which was increased to £2.0m as a result of an extensive restructuring programme. Further restructuring can be expected during H2, as new managers across the division assess the impact of the more challenging trading environment.

Braemar Offshore, supplying services to the South-East Asia offshore market, suffered a number of contract delays, accentuating the impact of reduced activity levels. Considerable cost was taken out of the higher cost operations in Singapore and Australia, the benefits of which should be seen in H2, despite the continuing tough trading climate.

There was a similar story at Braemar Engineering. It had been expected that new contracts in the US and Europe would emerge to fill gaps in the order book following completion of a major Nigerian contract, overseeing the design, construction and commissioning of three LNG carriers. We understand from management that the business has a very high level of enquiries, but several orders have been deferred pending greater clarification in the market place. The company has restructured its UK team and relocated key personnel out in the field back to the main offices in London and Houston. Several potential customers had originally indicated that the long-term potential of LNG markets was encouraging them to proceed with new vessels, but fears about the duration of the present malaise has prompted a more cautious policy over the past few months. Cost cutting should lead to an improved H2 performance, but a return to last year’s performance levels will take time.

The two insurance-based businesses, Braemar SA and Braemar Adjusting, both reported more challenging conditions. SA has seen a sustained level of in activity, especially in South-East Asia, but the average incident value was lower; diversification plans continued and the signs are still promising but will take time to deliver increased profits. Adjusting did well in the Middle East and Singapore, while the tougher conditions in the UK, US and Canada are being countered in H2 with a number of new instructions.

Braemar Howells, the environmental problem-solving business, delivered modest progress. No new major incidents arose, but the underlying business continues to develop steadily.

Logistics experienced a mixed half year, with the ship agency business delivering useful progress, although it was insufficient to balance the impact of more challenging trading conditions for the freight forwarding operation. Divisional revenue was virtually unchanged, rising by just 0.2% to £17.7m, but there was a 12% reduction in operating profit at £0.9m.

The main factor behind the varied performances was probably timing. Action to broaden the base and quality of the ship agency business began some three years ago and is already delivering useful returns despite the challenging trading conditions. The change of leadership in freight forwarding was much more recent – investment in strengthening the teams in Houston, Atlanta and Singapore are only just starting to deliver new business, with management targeting an improved result during the second half.

The chairman’s statement highlights action taken by management to address the cost-base in the light of the more challenging trading environment. Investment in recent years has created an overall business that is less vulnerable to the volatility of the shipping cycle, while the approach to seeking out and exploiting opportunities for organic and acquisition-based growth has not changed.

In Shipbroking the 2014 merger with ACM transformed the business. Integration of the two dealing desks was successful, with a positive attitude across each of the teams, despite the uncertain conditions in several segments of the market. The wet market remains today’s success story but teams in both the offshore and dry cargo sections continue to look more widely for business opportunities despite challenging market conditions. Meanwhile, the sale and purchase operation is linking much more closely with the special projects desk to secure new leads. Our forward profit estimates are naturally cautious, but there are growing opportunities to take on key teams or individuals that can add to the overall business.

The toughest challenges are currently in Technical. Management has acted quickly to cut costs, where appropriate, but is still looking for opportunities to move forward. We understand that recent management changes within the division will lead to closer liaison between the various divisional companies on a regional basis to develop cross-selling opportunities. Acquisitions remain firmly on the agenda; the number of potential deals has increased with the more challenging trading climate, but any deal will have meet stiff criteria. Consideration payable must reflect the risks involved, however, we sense that many asking prices are still too high.

Although not yet reflected in the bottom line, Logistics has responded positively to recent management changes. Both core parts of the division are targeting higher value-added work and walking away from unremunerative commodity-type contracts.

While the share prices of each of the other members of its peer group have traded within a fairly narrow band since publication of our Outlook report last May, the Braemar share price has fallen by 28%. This reflects the tough trading climate for both shipbroking and the oil & gas sector, as epitomised by the group’s trading update, issued in late August, which led to sharp reductions in consensus estimates. It is no coincidence that Clarkson, the global leader in shipbroking was the weakest performer of the remainder of the peer group (down 13%), as it was facing many of the group’s challenges. Braemar’s high exposure to deep sea oil tankers has limited its shipbroking difficulties, but the sharp falls in oil exploration activity has also been recognised in the share price.

While we have cut our estimates sharply, Braemar’s prospective P/E rating is 28% below that of Clarkson on the basis of prospective CY16 earnings, rising to a 35% discount on the basis of those for CY17. It is also rated at a discount to each of the other members of its peer group. We believe that this discount reflects market fears about the continued strength of the tanker market and the timing of recovery in oil exploration.

The main support for the shares remains in the strong balance sheet and high dividend yield. While management will, naturally, make no forecast about future dividends, the maintained interim and the prospect that it will be covered by consensus FY18 estimates, suggests to us that the payment will be maintained.

The cautious note in the pre-close trading statement published in August made it clear that interim figures would be well below earlier expectations; this was borne out by the drop in H1 adjusted PBT from £7.0m to £3.0m. The Q2 downturn in tanker spot rates suggests that H2 Shipbroking profits will be below those declared in H1, although the recent recovery in rates and the cost-cutting measures suggest that the shortfall will be limited. On the other hand, returns in both of the other divisions should show useful recovery, stemming from the restructuring in Technical and the new contracts reported in Logistics. At the time of the August statement, we reduced our FY17 adjusted PBT estimate from £13.5m to £8.8m. In the light of the full interim statement, we have decided to edge this lower to £8.5m. The resultant EPS, on the basis of an indicated 24.5% tax charge, of 21.4p would leave the unchanged dividend of 26.0p uncovered.

The restructuring, which has continued into H2, should benefit profits into the future. At the time of the August statement we reduced our FY18 adjusted PBT estimate from £14.0m to £11.7m. While trading conditions may be a little more challenging than we had been expecting, the potential cost benefits of the restructuring should be correspondingly higher, while the impact of the movement in the £/US$ exchange rate will also come through to profits. We have decided to leave this estimate unchanged; EPS of 29.3p would also cover a maintained dividend.

The balance sheet at August 2016 shows net cash of £0.7m, compared with net borrowings of £3.1m 12 months earlier and net cash of £9.2m at February 2016. The cash outflow over the half year was largely seasonal, related to the timing of the staff bonus and the final dividend. Despite the tough trading conditions, our current estimates show a £2.2m reduction in the y-o-y net cash position at February 2017. The group owns a 2% stake in The Baltic Exchange, which is the subject of an agreed bid by Singapore Stock Exchange – if the transaction completes, Braemar will receive £1.8m for its stake, including a one-off profit of £1.5m, boosting net funds further.

The group has negotiated a new £30m facility with HSBC, comprising a £15m RCF and a £15m accordion facility; the latter is available to help finance potential acquisitions.