We have always been quite fond of freight forwarders – and Expeditors is one of the best. The business model, stability and predictability resonate with our investment philosophy, and in addition, the company has an incentive programme with some mechanisms and requirements that are very rare to find. The CEO has to own shares in the company amounting to 60 years’ worth of salaries – so it is fair to say that this makes the top management team’s interests coincide with the interests of shareholders.
Expeditors International of Washington – or simply Expeditors – has been focused on organic and profitable growth ever since the company was founded. Based on a customer-focused and value-focused corporate culture, the operating efficiency is among the best in the business, and the long-term stability and predictability are impressive.
Expeditors is a freight forwarder based in Seattle, Washington in the USA, which provides services to customers all over the world, but with a particular focus on North America and Asia. Expeditors was founded in 1979, but a large part of Expeditors in its current form traces its roots to when, among others, Peter Rose, Glenn Alger and James Wang joined the company in 1981. Peter Rose would be the CEO for the next 25 years.
When clothes, electronics or other products are manufactured in one country and need to be shipped to another, Expeditors assists in getting them shipped from A to B as smoothly as possible.
Expeditors’ activities include air and sea freight. And it is well worth noting that as a freight forwarder, Expeditors does not own many significant assets, such as aircraft or ships.
The core competencies of manufacturing companies are in manufacturing and in the optimisation of production lines, but they are typically not as focused or skilled when it comes to managing shipping optimally. This is where freight forwarders like Expeditors come in, as they assist in getting the products shipped from A to B.
When Expeditors’ customers have asked for a quote on a shipment, Expeditors collects quotes from its suppliers, i.e. the airlines or shipping companies, and then Expeditors sells those services to its customers in return for a service fee which may include handing the documentation and customs paperwork, ongoing management of problems that arise etc.
Volatility means good opportunities for high earnings
The absence of owning major tangible assets such as aircraft and ships has a positive impact on the stability of earnings and so does the fact that freight forwarders do not need to make any major investments. And finally, these factors also have a positive impact on the profitability of the business.
Another advantage is that Expeditors has no preference when it comes to offering customers transport by air or sea, and they can thus evaluate the shipment solely based on the customer’s requirements for speed and safety.
Expeditors is extremely profitable with returns on invested capital exceeding 50 percent – a number that is higher than what is achieved by its competitors and a clear reflection of the attractiveness of its business model and the highly competent management team.
The fee that customers pay to Expeditors depends on a number of factors, such as the type of shipping, the length, size and requirements for time and complexity involved in making the customs declarations etc. Since shipping rates can fluctuate wildly, it can be hard for Expeditors’ customers to determine what a shipment ought to cost. Therefore, it can be particularly profitable for freight forwarders when the shipping rates are volatile.
Expeditors’ reported revenue is around 8 billion US dollars per year, of which the majority, around 70 dollars out of every 100 dollars in revenue is paid to shipping companies and airlines. The remaining 30 dollars belong to Expeditors.
The net revenue is the management’s primary objective for a so-called top line. The net revenue indicates what the gross profits are after having paid shipping companies and airlines for the freight services.
Since it was founded in 1979, Expeditors’ strategy has been focused on organic growth, and the impressive business has therefore been built without major acquisitions. The lack of acquisitions has helped maintain the strong corporate culture, focused on both the retention of existing customers and winning new customers. The culture is supported by a focus on optimising the long-term value creation rather than targets for quarterly earnings. This was reflected by the management’s decision to not dismiss employees during the global financial crisis in 2008 and 2009. The retention of employees is assessed as having had a positive impact on Expeditors’ ability to retain customers, as the customer care was still handled by the same people.
Via our ongoing communication with several of Expeditors’ competitors, it is our strong impression that it is extremely rare that competitors succeed in winning customers from Expeditors. This has allowed Expeditors to win market shareby attracting new customers and increasing the amount of business they do with existing customers.
Significant requirements for the management’s ownership of the company’s own shares
The staff has an industry-leading low turnover rate, and any replacements are typically made early on in the employment tenure. It is a strict requirement that the employees share the strong customer focus and are able to generate profits within this corporate culture.
Jeffrey Musser is the CEO of Expeditors, and he is only the third CEO since Expeditors was founded in 1979. Jeffrey Musser was promoted to his current role in 2016, after the previous CEO, the legendary Peter Rose, stepped down after 25 years as CEO. Since the beginning, Expeditors’ values have revolved around prioritising customers and operations, and therefore, communicating with the capital markets is not a priority.
The long-term value creation is also based on the close relationships with customers and the business that such ties can create. The need to access the capital markets – and by extension, the subsequent need to communicate with analysts and investors – has been limited, perhaps even non-existent, due to the organic growth strategy and the significant annual free cash flows.
We have a positive view on the management team’s remuneration programme which, among other things, sets high requirements for the management’s ownership of the company’s shares. For example, the CEO is required to own an entire 60 years of base salary in shares (and Jeffrey Musser already meets this requirement), and this means that the CEO has the same interests as minority shareholders such as us.
The base salary is limited to 100,000 dollars a year for the management, but on top of this, they receive bonuses based on the current operating income. 10 percent of the operating income is reserved for bonuses, and the employees receive a predetermined percentage of this. The majority does not go to the management, but rather the employees.
For the CEO to get a bonus, however, it is required that the growth in operating income must be at least five percent. No one gets a bonus if previous decline has not been exceeded – i.e., they use a so-called high-water mark.
Fortunately, the operating income is extremely stable over long periods. Even in tough times with large decreases in volume, the company still generates positive earnings. Since the company was founded in 1979, there have been no years or even quarters with operating losses. Shipping volumes fell drastically during the financial crisis in 2009, but Expeditors generated positive operating income, even if it was 19 percent lower than in 2008. Already by 2010, however, the operating income exceeded that of 2008 by a significant amount. This is just one of many examples of why we only see limited operational risks in logistics companies.
The solutions are much more complex than what trading platforms can provide
Despite technological advances, global trade lanes still require a lot of documentation of varying degrees of complexity. Many companies do not need to ship many containers per month, and therefore it does not make sense for them to use significant resources to become logistics experts.
As we see it, the complex procedures and regulatory requirements make it hard to compare freight forwarders with digital trading platforms, as the services vary from customer to customer and shipment to shipment. Nevertheless, we have often seen this comparison in recent years, where, for example, the American company, Flexport, was valued at a billion dollars with less than 500 million dollars in revenue and while it was clearly operating at a loss in 2018. For Expeditors, the revenue in 2019 exceeded 8 billion dollars, the operations were very profitable, and the market value was almost 13 billion dollars.
The services provided by a freight forwarder involve much more than just booking space on a ship or an aircraft, and booking transport is only estimated to account for every fourth dollar in net revenue. Three out of four dollars in net revenue are thus from additional services, such as customs declarations or preparing other kinds of documents. On top of that, Expeditors can optimise shipping between customers and thus optimise the profits per shipped unit.
The comparison with digital trading platforms underestimates the significant IT investments that are made by the major freight forwarders, including Expeditors. For Expeditors approximately every 20th employee works on the company’s own management platform, and over the years there have been, and continue to be, significant investments made in the development of this platform which connects the company’s more than 300 offices and 17,000 employees around the world. The lack of acquisitions has allowed all of the offices to remain on the same platform, and this promotes consistency and quality in the data used for the management’s strategic work.
Besides investments in IT, freight forwarders have a very limited need for capital investments. The annual investments (excluding IT), thus only amount to less than one percent of the revenue, and the funds tied up are limited to working capital. This is a major positive factor in achieving high returns on invested capital at Expeditors, which is also not weighed down by the accounting inclusion of goodwill from acquisitions.
One of the most important tasks for the executive management in any company is to allocate the ongoing free cash flows. Basically, cash flows can either be reinvested in the existing business, used for acquisitions, or distributed to shareholders via dividends and share buybacks. And finally, of course, the cash can simply be deposited in the bank and used for future expenses.
Expeditors generates significant cash flows, and with the operation and organic growth strategy not being capital intensive, Expeditors’ management generally only has to choose between two options: distributions to shareholders or saving the cash for the future. Considering that there were relatively strong earnings in 2009, when the financial crisis was at its peak, we would argue that there are good opportunities for shareholder distributions.
The annual dividend is one dollar per share, which is just above one percent of the market capitalization. In addition, Expeditors has a recurring share buyback plan with which they have bought back 400 million dollars’ worth of their own shares over the past 12 months – the equivalent of three percent of the market value.
Share buybacks are a good investment for a company if two conditions are met: First and foremost, the cash flows must cover more than merely the ongoing investment and operational costs. Secondly, the share price must be lower than the intrinsic value of the company. We view both of these conditions as being met in the case of Expeditors, which is why, as long-term shareholders planning to stick around, we get a large increase of the value of our investment via the share buybacks.
Despite high annual free cash flows and the absence of significant ongoing investments, the management maintains a very conservative approach to financing that does not include debt, but which does include around 1.2 billion US dollars in cash. This amounts to approximately seven dollars per share, or almost 10 percent of the current market value. Thus, the management will be able to buy back somewhere around every tenth outstanding share without taking on debt. As long-term oriented co-owners, we could wish that management had the same ambition of being best-in-class when it comes to capital allocation, just as they have for being best-in-class when it comes to operations. This should be in both the management’s and shareholders’ interest.
The long-term objective of the management is to grow the net revenue, operating income and earnings per share by double-digit growth rates. In addition to this, the so-called conversion margin – operating income as a percentage of net revenue – must be over 30 percent.
We find these objectives to be ambitious, but realistic. Expeditors has an industry-leading operating margin of more than 10 dollars for every 100 dollars in sales. The market for air freight has faced challenges in 2019 as volumes have decreased and thus earnings growth at Expeditors has been hit as well. The earnings per share in 2019 were thus a bit below what they were in 2018. In the last five years, however, the earnings per share have grown by 12 percent per year.
Freight forwarders are experts in getting their customers’ products from A to B safely and responsibly, and this involves working with documentation, following up on delivery times and so forth. The complexity of global trade helps create the foundation for earnings in logistics companies, and there are no indications that the demand for global trade is going to disappear.
A freight forwarder might sound simple, but it is the culture and attitude that separate the good from the bad – and Expeditors is one of the best.