EXPD - Expeditors International: Taking The Profit And Moving On

2023-12-21 10:49:28 ET

Summary

• Expeditors International of Washington stock has returned 24% since my first publication over a year ago, outperforming the S&P.
• While the original thesis rested on a strong performance in a slowing economy and low valuation, the situation has completely reversed this time around.
• The company's stock price has been boosted by stock buybacks, but declining income and rising valuations raise concerns.
• I believe the risks of holding this stock far outweigh the benefits. I have closed my position and will be reallocating the capital.

Expeditors International of Washington (EXPD) was my first coverage on Seeking Alpha. I have been investing for a while but this was the first company I decided to go public with my research which was more than a year ago. At that time there were many reasons to be bearish about the stock:

1. S&P 500 had entered a bear market and the US economy had seen a technical recession

2. The outlook for the economy itself was quite somber and there was a majority of opinion that the U.S will see a deeper recession towards the end of 2022 or early 2023

3. The company was seen as vulnerable to the U.S. economy. It had also been affected by a major cyber attack earlier in the year and the stock itself was off more than 30% from its 52-week highs and was undervalued.

My thesis was simple. The company had built up its earnings and balance sheet and it looked prepared for a bad outcome. It looked like it would not only survive well but also be poised for growth once the economic uncertainties ended. Additionally, it had proven this fact over and over again over the past recessions which gave us empirical evidence that the company knew how to survive and come out stronger. The stock was undervalued and it looked like all the bad news was already priced in.

Since publication, the stock has returned 24% handily beating the S&P. I think we find ourselves at a completely different juncture now. We have a strong economy behind us and the S&P is completely out of the bear market and kicked off a new bull market. This article will not only serve as a follow-up but also see how prudent it would be to hold on to this investment.

Slowing demand in a strong economy

Demand has decelerated over the last year and the news from the latest quarter continued this trend. The industry is also facing a period of oversupply, where the available shipping capacity exceeds the demand for shipping services in most lanes. This oversupply is a result of the significant adjustments and changes happening in the industry post-pandemic (Decline in rates in air and ocean shipping, abundant capacity, and rates remaining below the levels seen during the pandemic have contributed to this normalization)

The company has also observed that shippers are moving smaller volumes likely due to the result of inflation, high energy costs, tentative consumers, and growing geopolitical uncertainty. It recognizes three principal services when it comes to reporting revenues.

1) Airfreight Services: Revenues and expenses decreased by approx. 50% during the nine months ended September 30, 2023, as compared with the same period in 2022

2) Ocean freight and Ocean services: Revenues decreased 67%, while expenses decreased 71% for nine months ended September 30, 2023, as compared with the same periods in 2022

3) Customs brokerage and other services: Revenues decreased by 21% and expenses decreased by 34% for the nine months ended September 30, 2023, as compared with the same periods in 2022

Overall, Expeditors sees the business trending back to pre-pandemic levels and this is also quite evident when you look at the top and bottom line.

So what explains the upward movement in the stock price over the last year? It is certainly not the guidance or outlook as the company has repeatedly stressed that the pandemic windfall is normalizing to pre-COVID levels and the outlook is uncertain.

The historically high average buy and sell rates caused by the pandemic and unprecedented supply chain disruptions which contributed to the growth in our revenues, expenses and operating income in 2021 and 2022 have dissipated as supply chains operations normalized. Buy rates and sell rates have been declining since the second quarter of 2022 and could further decline in 2023 if capacity remains higher than demand. Additionally, uncertainty in the economy including inflationary pressure and rising interest rates together with the attractiveness of declining ocean transportation rates are expected to continue to negatively affect demand for airfreight services which could further reduce our volumes. These conditions could result in a further decrease in our revenues, expenses, and operating income. We are unable to predict how these uncertainties and any future disruptions will affect our future operations or financial results.

Declining income and rising stock price mean valuations have rapidly expanded from last year.

Any further decline in earnings means further expansion in valuation. At a -30% decline in earnings from here, we may see forward PE multiple expand quite beyond 30x.

The last time we saw a valuation in this range was back in 2011 and subsequently, we saw a stock price correction of more than 30% during the next year, and valuations fell in line with sector averages. There is a possibility that we could be setting up for a similar scenario.

Stock buyback

So coming back to our question. What is contributing to the movement in stock price? How in the face of normalizing top and bottom line and an uncertain outlook, the stock has marched toward all-time highs? I believe the answer lies in how the management has chosen to return value to shareholders. Management has been actively putting their cashflows to use by buying back their stock. The last few quarters have seen the largest amount of capital in the history of the company being put to work this way.

Essentially, this has reduced the share count to the levels it was seen 3 decades ago and has served to boost the price of the stock. The plan to repurchase stock was last amended at the beginning of the year and has no expiration date. So we may expect the management to continue to return value to shareholders in this regard for the foreseeable future.

The Company has a Discretionary Stock Repurchase Plan approved by the Board of Directors that authorizes management to reduce issued and outstanding common stock. The Board of Directors last amended the plan on February 20, 2023, to authorize repurchases down from 150,000 to 140,000 shares. This authorization has no expiration date. During the nine months ended September 30, 2023, there were 10,522 shares repurchased at an average price of $113.97 per share, compared to 9,529 shares repurchased at an average price of $106.84 during the same period in 2022.

Final Call

I am less confident this time around about the medium-term prospects of this stock. While we are moving toward the normalization of the business to the pre-pandemic times there is less clarity on how far this will go. Meanwhile, the valuation is marching higher supported purely by financial engineering, and is masking the issues faced by the company. Over the short-term, this may further boost the price but over a longer time frame further decline in the company's cashflows may not support this exercise (The company's balance sheet is a fortress and it may decide to borrow but I am not a big fan of using debt to buy back stock either). This makes me cautious and I feel I have better use for this capital than this stock (Even the management has been taking some of their chips off the table). Rating this as a Sell.

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