Tuesday, December 5, 2017


Analysis: high times for investors in Expeditors, but risks remain

expeditors building
The share price of Expeditors International climbed steeply after the US freight forwarder reported its latest trading update in early November.
Expeditors (EXPD) share price (Yahoo Finance)
Expeditors (EXPD) share price (Yahoo Finance)
One month later, it is high times if you are an investor, with the stock hitting a stunning record high of $65.40 last week, proving the company continues to do really well in what it is really good at, hard core freight forwarding and customs brokerage operations.
There is one caveat, however: the way it is funding growth is just as important as how the funds it raises are deployed, and whether certain cash outflows are sustainable.
Business model
As my Loadstar colleague Gavin van Marle wrote in early 2016: “Expeditors has long been a byword for a conservative approach to freight forwarding. It has generally eschewed acquisitions as a means of growth, preferring to grow organically by opening up its own offices and internal staff development. It has also stayed away from the contract logistics and supply chain management services that other forwarders have embraced as traditional freight forwarding margins have eroded.”
In a world where it is easy to argue that either entertaining M&A aimed at exploiting synergies or launching non-core logistics services might be the two most obvious ways to buck the trend of declining operating margins in freight forwarding, Expeditors remains focused on a core strategy that hinges on organic growth at a time when there appear to be no imminent risks, as far as capital deployment is concerned (this refers to allocation of funds towards acquisitions, share buybacks, dividends and internal projects that should drive growth).
Nonetheless, I found some working capital trends a bit disturbing and, as a result, worth paying attention to.
(As a reference, I previously flagged working capital management trends and related risks at one of its major competitors, Kuehne + Nagel.)
Cash flows
Earnings were flattish on a comparable basis in the first nine months of the year, but core operating cash flow fell, mainly due to a significant increase in trade receivables, or short-term credit that usually builds up as revenues rise, often leading to a lengthened cash conversion cycle (CCC).
EXPD operating cash flow 2016-2015 (Source EXPD)
EXPD operating cash flow 2016-2015 (Source EXPD)
Expeditors’ CCC was ok in the first nine months, which testifies to financial discipline; but as a result of rising volumes, operating cash flow dropped by $94m (a 21% decline year-on-year) to $362m, as the table above shows.
Revenues and earnings are the headline figures, but the real question is whether Expeditors can continue to repurchase stock and pay out more in dividends – admittedly, from a relatively low level and given a conservative dividend payout ratio – if cash flows become thinner.
So, its cash flows should be under the spotlight, and rightly so, because if productivity deteriorates, cash returns to shareholders will almost certainly take a hit.
EXPD P&L (Source EXPD)
EXPD P&L (Source EXPD)
If this seems a rather unusual approach to certain financial figures you may be less familiar with, that may be due to an underestimation of how cash flows are core in the capital allocation strategy of most companies. And even more so with Expeditors, which has long been a benchmark for its rivals globally – and recent results demonstrate that it ought to thank good management, as well as its clients, if it can continue to deliver shareholder value via larger buybacks and higher dividends that often lead to a rising share price, particularly when capital structures, as it is the case with its own balance sheet, are rock-solid.
The following two tables show the changes in core cash flows in the first nine months of the year between 2016 and 2015, and between 2015 and the previous year.
EXPD cash flow 3m/9m 2016 vs 2015 (Source EXPD)
EXPD cash flow 3m/9m 2016 vs 2015 (Source EXPD)
EXPD cash flow 3m/9m 2015 vs 2014 (Source EXPD)
EXPD cash flow 3m/9m 2015 vs 2014 (Source EXPD)
Not only was 2014 a key point when changes in receivables mostly impacted core cash flows, but also those cash outflows are not far off those for the first nine months of this year – which has represented a critical time in terms of price increases for clients, as we all know.
EXPD cash flow 3m/9m 2014 vs 2013 (Source EXPD)
EXPD cash flow 3m/9m 2014 vs 2013 (Source EXPD)
However, many major freight forwarders have failed to do that as competition for customers intensifies. Remember also that this is an asset-light business, so capex, by definition, doesn’t consume much investing cash, but recent numbers show one of the highest level of internal investment in capital expenditure in years.
EXPD Capex (Source EXPD)
EXPD capex (Source EXPD)
That, in turn, impacts free cash flow, which is the actual amount of cash devoted to finance buybacks and dividends, assuming debt is not a source of funding aimed at backing such activates, which applies here.
Earnings per share, or EPS, are artificially growing thanks to buybacks, while its share count has been shrinking at a fast pace. Meanwhile, cash outlays from financing – this is pure cash that comes in and goes out based on a number of financing sources – rose this year.
“Cash used in financing activities during the three and nine months ended September 30, 2017 was $137m and $254m, respectively, as compared with $44m and $193m for the same periods in 2016,” Expeditors said on 7 November, adding: “We use the proceeds from stock option exercises, employee stock purchases and available cash to repurchase our common stock on the open market to limit the growth in issued and outstanding shares.
“During the three and nine months ended September 30, 2017, we used cash to repurchase 3.6m and 6.1m shares, respectively, to reduce the number of total outstanding shares, compared with 2m and 5.4m shares in the same periods in 2016.”
This means continuity in terms of capital deployment, but what does that actually imply?
(As a reminder, in November 2001, “under a Discretionary Stock Repurchase Plan, Expeditors’ board of directors authorised the repurchase of our common stock in the open market to reduce the issued and outstanding stock down to 200m shares. In February 2014, the board authorised repurchases down to 190m shares of common stock. In February and August 2015 and May 2016, the board further authorised repurchases down to 188m, 180m and 170m, respectively”.)
Here we go: “During the nine-month periods ended September 30, 2017 and 2016, 3,189 and 2,579 shares were repurchased at an average price of $56.26 and $49.41 per share, respectively.”
Quite simply, if these trends persist, it will continue to entertain buybacks at a price that is closer to all-time highs, possibly diluting the benefits of earnings accretion, and putting more pressure on cash flows.
I am not a big fan of share repurchases, but Expeditors should not give up, although risks heighten if clients who are actively funding its value-led strategy wake up and smell the coffee, and price increases become more problematic.
The outlook is brighter, perhaps, particularly for air freight operations, given recent trends for air freight rates, but do not forget trading conditions and margins were less reassuring only a few months ago, when its stock changed hands in the low-mid-$50s.
Expeditors (EXPD) share price (Yahoo Finance)
Expeditors (EXPD) share price (Yahoo Finance)
Shippers carrying the burden
I wondered some time ago if the shareholders of CH Robinson, another major US-based asset-light business operating in logistics, played second fiddle to customers and, given its recent rise on the stock exchange, it seems likely that shippers are the ones asked to carry the burden of creating value for their forwarders’ shareholders.
Only three months ago, investors were unforgiving when a poor trading update raised many questions about Expeditors’ ability to boost profitability.
That is important, because operating profitability (as gauged by ebit margins, which are down) ultimately affects cash flows and dictates capital allocation strategies. In the third quarter, costs of goods sold rose at a higher pace than revenues, which is a problem affecting all major freight forwarders in the world these days.
However, operating costs at Expeditors grew less than revenues, while other operating costs were under control, so its operating income rose significantly at a time when most of its global rivals struggled to squeeze more cents out of each US dollar in sales. Which proves, again, financial discipline reigns here, yet risks remain, and I’m afraid that margin erosion is likely to also stay.