Expeditors International of Washington – Expeditors – is quite a unique freight forwarder. The Seattle-based company stands apart from the crowd by having a deeply embedded customer-centric service culture, and not just anyone can become an employee either. The returns on invested capital are at levels that competitors must be envious of.
When clothes, electronics, cars or other products are manufactured in one country or region but sold to a consumer in another, the goods need to be moved from A to B. Expeditors helps its many customers with these logistics, whether transportation is by air or sea.
Expeditors is a freight forwarder and thus does not own any planes or ships itself. For many manufacturing companies, logistics is not a core competence, and therefore they use freight forwarders to optimise and ensure the quality of the transport from factory to market. Freight forwarders, in this case Expeditors, therefore collect offers to handle the freight from, e.g., shipping companies or airlines, and then they pick the best one – in return for an additional fee. Shipping companies and airlines therefore bear the costs of the large capital investments, and these are significant cash outlays for shipping companies such as the ocean liner A.P. Møller Mærsk, which not only has to buy the ships, but also must devote significant cash flows every single year to maintain them.
Because of the absence of mentionable physical assets, Expeditors can achieve returns on invested capital of 50 percent – this is an impressive figure, and a clear sign of the appeal of the business model. By not owning the assets, Expeditors has no preferences for the type of shipping. They can decide solely based on the customer’s needs and requirements.
Complex requirements justifies the company’s existence
The fee paid to Expeditors depends on a number of factors, such as the type of transportation, the length of the journey, the size of the shipment, the time frame and the complexity of it – such as customs declarations etc. In times when freight rates fluctuate greatly, it can be hard for the uninitiated to figure out what a shipment “should” cost. Therefore, freight forwarders actually often see the greatest increases in revenue yields, when the rates are at their most volatile.
Expeditors’ sales to customers amount to almost eight billion US dollars. However, the majority of this is passed on to the suppliers of the transportation services, either the shipping companies or the airlines. Expeditors keeps about 33 percent of the sales, which management calls the net revenue. Management uses this as the primary objective for a so-called top line.
Despite technological advances, global shipping routes have a lot of complicated documentation requirements – and for companies that might need to transport three, four or maybe five containers each month, this is not something they become experts in dealing with.
These complex procedures and regulatory requirements make it very difficult to compare freight forwarders with digital trading platforms, as the services provided vary from customer to customer and from shipment to shipment. The service is about a lot more than just booking some capacity on a ship for a few containers – this part of Expeditors’ services is estimated to represent about 25 percent of the net revenue. However, this means that 75 percent of the net revenue are from other services than the transportation itself – for example, managing customs declarations or a long list of other required documents. Furthermore, Expeditors can sometimes optimise and schedule shipments so that one booking with a supplier can be used for several customers, thus optimising the profit per unit.
Extremely low levels of capital
A comparison with digital trading platforms further underestimates the significant IT skills that freight forwarders have today. In this Seattle-based company, every 20th employee is actually working within IT, and throughout the years, significant investments have been made towards the development of the company’s own operations platform. This platform is used by more than 17,000 employees across the company’s 300 offices around the world, and this leads to the creation of a good and highly useful source of data, which can in turn be used to optimise the decision-making processes of the management.
Besides the investments made in the company’s IT platform, the capital expenditures are limited. Growth mainly requires additional computers and offices where the company’s employees can seek out new customers, and work to retain current ones. The capital expenditure thus only amounts to approximately one percent of annual revenue. The capital tied up is thus extremely low compared to most other industries. This is a major factor in Expeditors’ high returns on invested capital, and it is not negatively impacted by goodwill from acquisitions.
Management’s focus on solely growing organically has had an extremely positive effect in terms of optimising processes, and it has also helped to maintain the company’s very special customer-centric culture. This culture is supported by a focus on optimising the business to create the best possible long-term value. This is reflected by management’s decision to not dismiss employees during the financial crisis of 2008 and 2009. Employees were kept onboard, and this is also judged to have helped keep customers onboard, as their contact people remained the same throughout this turbulent period.
The low levels of staff turnover are industry-leading, and the few times that employees are replaced, it generally happens during their first year. The right attitude is required before a new hire is considered a success, and the right attitude is to keep the focus on doing proper and profitable business with the customers who are a right fit in the long term. Through our ongoing communications with several of Expeditors’ competitors, we are continually reminded that it is extremely difficult to lure customers away from this freight forwarder. Expeditors has therefore managed to increase its market shares, by expanding activities with current customers while also attracting business from new ones.
High shareholding requirements for the CEO
Expeditors’ CEO is Jeffrey Musser. He is only the third CEO since the company was founded in 1979. In 2016, Musser took over from the legendary Peter Rose, who had been at the helm for 25 years, when he stepped down. Since the beginning, the values have been focused on providing the best possible customer experience while limiting both time spent and focus on the stock market and analysts. A company should not be run with the stock market in mind, it should be run to create the best possible long-term opportunities for stable and increasing free cash flows.
We have a positive view of the company’s incentive scheme, which, among other things, includes significant requirements for the ownership of the company’s shares – Jeffrey Musser, for example, is required to own shares amounting to 15 years’ base salary. Musser owns quite a lot more than this, and we therefore find management’s interests tightly aligned with the interests of the remaining shareholders. Management receives a limited base salary of 100,000 dollars, but on top of this, they are awarded bonuses based on the development in operating income, and cash are set aside on an ongoing basis to pay for this. The individual employees receive a predefined percentage of this, with the reservation that the CEO only receives his share if the growth in operating income exceeds five percent. No one gets a bonus if previous declines have not been exceeded – i.e. a high-water mark.
The operating income is extremely stable. As an example, during the financial crisis, despite significant declines in global trade (and thus transported volumes), in 2009 there was a decline in operating income of barely 19 percent. Already by 2010, this and more had been recovered.
From 2008 to 2010, the operating income thus grew by an average of more than seven percent despite the decline in 2009. Expeditors has not had a quarter or a year with negative operating income since it started, and this speaks to why we generally find little risk in well-run freight forwarders.
Significant operating cash
One of the most important management tasks is to allocate the free cash flows that the company generates. In brief, these can be allocated between investments that grow the business (either by growing the existing business or via acquisitions), distribution to owners via dividends or share buybacks or by depositing the earned cash in the bank.
As previously mentioned, the annual capital investments in new business are limited in this business model, and therefore there are ample opportunities for distributing capital to shareholders. Expeditors pays an annual dividend of close to one dollar, which is equivalent to a direct yield in excess of one percent. On top of this, there are significant share buybacks equivalent to more than five percent of the market value.
Share buybacks are a good investment for a company to make, if two conditions are met: First and foremost, the cash flows must more than merely cover the ongoing investment and operational costs. Secondly, the share price must be lower than the intrinsic value of the company. We find both conditions are met in the case of Expeditors, which is why we, as long-term investors plan to stick around, as we receive a lot of value through the share buybacks.
Despite high annual free cash flows and the absence of significant ongoing investments, management maintains a very conservative approach to financing, that does not include debt, but which does include around one billion US dollar in cash. This amounts to approximately 5.6 dollars per share, or eight percent of the current market value. Thus, management would be able to buy back somewhere around every 12th outstanding share without taking on debt.
The long-term objective of management is to grow net revenue, operating income and earnings per share by double-digit, annual 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 10 percent. Over the last five years, net sales and operating income have grown by more than seven percent, and earnings per share have grown by more than 14 percent annually.
Faith in success despite talk of a trade war
Expeditors is a major beneficiary of the tax reform in the United States that should lead to a reduction of the previous tax rate for the company, which was around 35 percent. While the average growth rate for earnings per share was almost ten percent for the five years up to and including 2017, the growth was 30 percent in 2018.
There has been a lot of talk about trade wars and the risks of a slowdown in global trade in the past years, but this has not led to changes in the business models of freight forwarders – nor has it had a noticeable effect on the development in the volume of goods transported. The complexity of trade routes and the requirements for documentation, can actually be seen as an advantage for freight forwarders. They are experts in getting their customers’ cargo from A to B, with everything this entails along the way. The complexity can make it even more important to partner with a good freight forwarder. This is the core of Expeditors’ model. A freight forwarder may, all other things being equal, sound like a simple business, but it is the culture and attitude that makes all the difference – and Expeditors is one of the best.