EXPD - Expeditors International: Turbulence Ahead

2023-08-22 12:44:29 ET

Summary

• Expeditors International benefited from disruptions caused by COVID-19 but is now facing downward pressure on earnings as supply chains return to normal and consumer spending fades.
• The company operates as an asset-light, service-based logistics company, offering end-to-end logistics solutions and serving a diverse range of customers.
• Expeditors' financial track record has been strong, but its recent Q2 2023 earnings report showed significant declines in key metrics, suggesting a challenging outlook for the company.

Expeditors International (EXPD) was one of the dominant global freight forwarders that capitalized on the disruptions brought on by COVID-19, benefiting immensely from the congested supply chains and heightened demand for air and ocean freight capacity.

However, as the current environment gradually returns to normalcy, ocean and airfreight rates have descended from their pandemic-induced peaks. The shift from goods to services and fading consumer spending will put downward pressure on Expeditors' future earnings.

The shipping industry grappled with significant financial and operational strain over the past year, requiring logistic companies to focus on enhancing supply chain resilience. While Expeditors remains a dominant figure in global logistics, it is not immune to shifting supply chains. Expeditors must navigate challenges posed by shippers eager to recuperate from financial setbacks experienced during the global crisis.

Business Model

Expeditors International is an asset-light, service-based logistics company. It operates a vast global network, featuring over 176 district offices across more than 60 countries spanning six continents. Despite not owning tangible assets like aircraft or vessels, the company has carved a niche for itself by offering end-to-end logistics solutions. These services include pickup and delivery to the original port, freight transportation from source to destination ports, and ensuring smooth customs clearance for final delivery. Their diversified customers span across different sizes, industries, and geographical locations.

Freight forwarders like Expeditors play a pivotal role in global logistics. These intermediaries facilitate the global movement of mainly finished and semi-finished commodities, acting as a bridge between shippers and carriers. Their strength lies in securing efficient transportation deals, often at costs unreachable for smaller shippers. By integrating multiple shipments and leveraging their purchasing power, they can negotiate for cost-efficient rates from carriers. Subsequently, this leads to them offering competitive prices to their customers. The process has complex stages such as origin handling, navigating through export and import customs clearances, and finally, destination handling.

A notable distinction is that freight forwarders, unlike brokers, can physically hold onto shipments, often involving storage, packaging, and dispatching. Expeditors predominantly function as an indirect carrier, issuing documents like the House Airway Bill , House Ocean Bill of Lading , or House Seaway Bill as contracts of carriage to their clients. When transferring freight to a direct carrier, they obtain a subsequent contract of carriage. Notably, the company bears liability for lost or damaged consignments, a responsibility defined in their client agreements.

Freight forwarders, revenues reflect available volumes and the difference between buy and sell rates for ocean and airfreight. Although the market is heavily fragmented with similar competition, larger forwarders possess an edge by virtue of their scale. They can handle more capacity, which becomes particularly advantageous during market constrictions. However, in softer markets, shippers are known to seek discounts aggressively.

Operating Segments

Expeditors have a vast array of transportation services and solutions. These range from customs brokerage, order management, cargo insurance, temperature-controlled transits, to special cargo monitoring and tracking. Additionally, the Project Cargo unit caters to shipments necessitating specialized attention. Broadly, these services are categorized into three primary operating segments: Airfreight Services, Ocean Freight and Ocean Services, and Customs Brokerage and Other Services.

Their revenue stream in 2022 primarily flowed from three channels: airfreight services (35%), ocean freight/ocean services (38%), and customs brokerage and other services (27%).

Airfreight Services

Airfreight services accounted for 35% and 41% of Expeditors' revenues in 2022 and 2021, respectively. Expeditors often take on the roles of freight consolidators or agents for an airline that carries the shipment (forwarder). They offer clients routing expertise, nuanced knowledge of local business customs, and an understanding of export-import documentation and procedures. Notably, they also assist clients in securing cargo capacity during high-demand periods. Shipment by air is relatively expensive compared with ocean transportation; a high value-to-weight ratio, the need for rapid delivery, or both generally characterize air shipments.

Ocean Freight and Ocean Services

Ocean freight services accounted for approximately 38% and 34% of Expeditors' revenues in 2022 and 2021, respectively. From the second half of 2020 into the first half of 2022, there was a significant surge in the need for sea transport. This led to notable port backups and interruptions in the supply chain, especially on routes from the transpacific and between Asia and Europe.

Expeditors are classified as a Non-Vessel Operating Common Carrier (NVOCC), which collaborates with ocean carriers, locking in rates for transporting a predetermined number of containers between specified locations. Catering to full container loads and less-than-container (LCL) freight, they offer a broader spectrum of shipping options than most carriers. Revenue also streams from ancillary services, such as document preparation to comply with international trade laws.

Customs Brokerage and Other Services

Customs brokerage and other services accounted for approximately 27% and 25% of Expeditors' revenues in 2022 and 2021, respectively. It revolves around aiding importers in navigating customs procedures by managing documentation, computing and remitting duties and taxes, coordinating governmental inspections, and even orchestrating local pickups and deliveries. By screening commercial documents for criteria like assessed value and country of origin, they target shippers aiming for streamlined customs processes and improved global trade program participation.

Financial Overview

Expeditors has a solid financial track record as they have consistently outperformed the S&P 500 and Industrials sectors, even during recessions. This impressive track record can be attributed to its asset-light business model, high free cash flow conversion, and strategic capital allocation.

The COVID-19 pandemic served as an advantage for Expeditors. Its revenue and EBIT witnessed a sharp incline from 2Q20, mirroring the escalating ocean and airfreight rates. The company experienced substantial YoY EBIT growth, especially in 2H20, with airfreight rates skyrocketing. But the most significant leap was observed when the ocean index surged due to unparalleled demand.

Expeditors grew its revenues by 73% from 2020 to 2021 and grew its EPS by over 100% during the same period. The company took advantage of this rapid cash flow by buying back its stock. From 2020 to 2022, Expeditors bought back $23m shares, reducing their outstanding share count by 10% (169m to 150m today). Despite management's choice to boost earnings inorganically, Expeditors saw its recent EPS fall 43% YoY in its 2Q 2023 earnings report. Expeditors' share price is up 9% YTD, but its price dropped by 10% after its earnings release on August 8th, 2023.

Q2 2023 Earnings Commentary

Expeditors reported Q2 2023 earnings on August 8th, 2023, and there wasn't much to celebrate. I list below the key highlights from the results compared to Q2 2022.

• Diluted Earnings per share decreased by 43% to $1.30.
• Net Earnings Attributable to Shareholders decreased by 48% to $197 million.
• Operating Income decreased by 51% to $248 million.
• Revenues fell 51% to $2.2 billion.
• Airfreight tonnage volume decreased by 15%, and ocean container volume decreased by 13%

The sharp declines across essential financial metrics are red flags, and the management's somber outlook doesn't provide immediate hope for a swift recovery. Expeditors' management commentary does give some context.

Looking forward, we will continue to thoughtfully manage down our headcount and exert other efforts to align our costs with these lower levels of demand. In many ways, current conditions are very much the reverse of what we experienced in the early days of the pandemic, as the current marketplace shifts to a lower gear on increased capacity and falling rates and demand. We do not see those conditions changing meaningfully before the end of the current year. Shippers are cautious, the economy remains uncertain, and carrier capacity does not adequately reflect the current levels of marketplace demand (Jeffrey S. Musser, CEO).

The logistical landscape Expeditors once thrived in during the pandemic's peak has drastically changed. Their decision to "manage down headcount" speaks to a strategy of containment and cost-cutting – a practical move considering decreased demand. Still, it also signals a potential longer-term contraction rather than a brief downturn.

Expeditors is the only company I know that doesn't conduct public quarterly earnings calls. You can find their 2Q 2023 press release here .

Final Thoughts

The uncertainty in the economy and management tone suggests that this isn't just a short-term problem. The imbalance between carrier capacity and market demand is poised to cause inefficiencies. Even in this market, Expeditors' defensive characteristics are unlikely to be pursued as a safe-haven investment.

Overall, while the immediate outlook provided by the management doesn't seem promising for the end of the year, it's essential to take a long-term perspective. If Expeditors can navigate this rough patch by growing earnings amidst economic uncertainty, a compelling investment thesis could still be here. However, monitoring how effectively the company implements its strategies in the coming quarters is crucial before making any investment decisions.

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