Expeditors International of Washington (Nasdaq: EXPD) is a former cult/broken-growth stock among GARP investors that has fallen out of favor as near-term macro and industry specific challenges have impeded the company’s ability to grow earnings at the same rate as it did in the prior fifteen years.  At current levels of $40 per share, you can buy a still-terrific business at less than 11x  forward EBITDA-Capex, and a 7% forward free cash flow yield (ex its nearly $7 of net-cash per share; the vast majority of which has been properly taxed and repatriated).  Though not cheap on an absolute basis, the company has limited downside risk due to its asset-light, non-cyclical (more on that below), self-funding business model as reflected in its consistent ROIC exceeding 20% through all cycles.  At current multiples, Expeditors trades right around its historical  trough 2008-2009 multiples and we believe an investment in Expeditors today provides a compelling risk-reward proposition with the potential to generate double-digit returns with limited downside.  We believe that with the large amount of cash on its balance sheet, there is also the opportunity for a more attractive return propelled by either a large share repurchase program or a potential takeout or merger.

Company Description

Headquartered in Seattle, WA and incorporated in 1979, Expeditors is engaged in the business of providing global logistics services by essentially serving as the “middleman” between customers or shippers (e.g., manufacturers, retailers, etc.) and direct carriers (e.g., ocean shipping lines, airlines) and collecting a spread for this service.  The Company’s value proposition is that by consolidating shipments from multiple customers, offering a seamless international network (with 13,790 employees and 188 full-service offices and numerous satellite locations located on six continents), and concentrating its buying power, it can negotiate favorable buy rates from the direct carriers, while at the same time offering lower sell rates than customers or shippers would otherwise be able to negotiate themselves.  The spread that Expeditors earns is termed “net revenue”.

The Company has historically pursued an organic growth strategy, based on their emphasis on culture, IT systems, long-term customer relationships, customer service, and professional development of employees.

For the twelve months ending June 30, 2013, Expeditors generated $1.83bn in net revenues and $588m in adjusted EBITDA (32% margin).  Specifically, Expeditors derives its revenues from three principal sources: (1) airfreight services (34% of net revenues); (2) ocean freight and ocean services  (24% of net revenues) and (3) customs brokerage and other services (42% of net revenues)

After a couple recent challenging quarters, the Company grew market share last quarter, as referenced by their CEO, Peter Rose: “While the global economy is still slowly emerging from the fundamental problems that have held it in thrall over the last five years, and slowly is the operative word, we’ve selectively grown market share this quarter.”

Airfreight Services

Expeditors provides airfreight services by procuring shipments from its customers, determining the routing, consolidating shipments bound for a particular airport distribution point, and selecting the airline for transportation to the distribution point.  At the distribution point, Expeditors or its agent arranges for the consolidated lot to be broken down into its component shipments and for the transportation of the individual shipments to their final destinations.  The average airfreight consolidation weights approximately 2,500 lbs and includes merchandise from several shippers.  Because shipment by air is relatively expensive compared with ocean transportation, air shipments are generally characterized by a high value-to-weight ratio, the need for rapid delivery or both.

Expeditors maintains a preferred list of carriers, primarily using a network of 19 airlift providers across the globe.   

For the quarter ending June 30^th, total airfreight kilos increased 5% year-over-year, resulting in a 4% increase in airfreight net revenues.  While the global airfreight market has improved relative to the prior two years (especially the Asia-U.S. lane where EXPD derives most of its revenues),  the tonnage growth that EXPD realized from ’04-08 (14%, 17%, 8%, 12%) will probably be difficult to replicate going forward.

Ocean freight and ocean services

As a provider of ocean freight services, Expeditors contracts with ocean shipping lines to obtain transportation for a fixed number of containers between various points during a specified time period at at an agreed rate.  The Company handles full container loads for customers that do not have annual shipping volumes sufficient to negotiate comparable contracts directly with the ocean carriers and for those customers that prefer to have the flexibility that Expeditors multiple carrier contracts and sailings offer. 

Expeditors also provides ocean forwarding services whereby Expeditors acts as an agent for the steamship lines, taking a fee for certain shipping services.  Like its core offering of ocean freight services, EXPD generates revenues from ancillary services such as preparing documentation, procuring insurance, arranging for packing and crating services and providing consultation.

The final part of this reporting segment is order management, which manages origin consolidation, supplier performance, carrier allocation, carrier performance, container management, document management, destination management and purchase order/SKU through a web-based application.

For the quarter ending June 30^th, ocean freight volumes increased 2% year-over-year with June being the best month, resulting in an expansion of yield of 230 bps, despite what has been a period of sustained softness in the international airfreight market.  This also represented a third straight quarter of share gain.

Customs brokerage and other services.

As a customs broker, Expeditors assists importers to clear shipments through customers by preparing required documentation, calculating and providing for payment of duties and other taxes on behalf of the importer, arranging for any required inspections by governmental agencies and arranging for delivery.  Historically, EXPD has performed customs clearing services on approximately 75-80% of the freight that is touched by its forwarding and consolidation businesses.

With the increased emphasis on homeland security in the United States and resulting increase in regulation, clearing customs has become far more complicated and burdensome for customers – which has benefitted Expeditors.  For the years 2006-2012, revenues have grown 22%, 16%, 9%, -10% (2009 recession), 17% 14% and 2% respectively.  Notably the 2% growth was in an environment where the company’s airfreight net revenues declined 12%. For the quarter ending June 30^th, revenues grew 2.1%.

Investment Thesis

High quality business

As a non-asset based carrier, the Company does not own or operate transportation assets, such as aircraft or steamships, enabling it to flex its cost structure thought different environments and maintain margins. (in fact, during 2009, despite a 27% decline in gross revenues, Expeditors maintained a 32% net revenue margin)   The flipside of course is it limits operating leverage, but in an industry that is leveraged to the global economy, we believe this is an advantaged long-term business model.

By taking a spread while leveraging its global presence, Expeditors benefits from a network effect and also can maintain margins during a global downturn, when carrier unused capacity is high (i.e., EXPD can negotiate lower rates from the carrier, while passing on only a percentage of such savings to the customers).  Expeditors is considered the best-of-breed operator, and has consistently generated ROIC greater than 20%, and its long-term relationships and overall competitive positioning are the envy of several other players in the industry.

Other competitive advantages include a best-in-class, organically built IT-system, a global and scale presence in nearly every major market, diversified customer base (no customer is more than 5%), and a sticky customs brokerage business.

Compelling valuation

At $40 per share, EXPD is trading near its trough multiple, with forward EBITDA and P/E multiples well below five year averages, and close to their 2009 recession multiple.  Though EXPD has historically traded at a (very) rich multiple – averaging nearly 16x EBITDA-capex  from 1999 to 2010 due to its high ROIC, consistent EPS growth (growing EPS 20%/year from 1993-2010) and competitive positioning, the multiple has contracted over the last two years with a stagnant stock price despite the market rally, as EPS growth came to a halt in 2012.

We believe that this high quality business has been over-penalized recently due to fears around macro-concerns, global “insourcing” and competitive dynamics.  The business is undervalued by at least 20%, and near-term rebounds in global shipments, a return to EPS growth with easier comps, and prudent capital allocation should close this gap.

Strong balance sheet provides flexibility

As of June 30^th, the company had $1.37bn of cash, cash equivalents and short-term investments ($7 per share) with no debt.  While the company repurchased 27m shares over the six prior years, including 8m shares (on a base of 214m) last year, and has consistently increased their dividend, EXPD could be even more aggressive with its share repurchase program.

Alternatively, though the company has stated on several occasions that it prefers to be independent and would eschew the idea of being acquired by a larger company or merging, the industry has evolved and there may be growing frustration among stakeholders that may impact this view.  If this were to occur, we believe that the acquirer would find major tax savings/restructuring opportunities, as EXPD, despite its global presence and truly international business model, pays a 39% tax rate.

Experienced and well-incentivized management team

Prior to the last two years, the management team, led by CEO Peter Rose, with a track record and history of superior execution, was held in high regard not only by industry participants but also Wall Street.  The team still has a sterling reputation in the industry, but is now viewed as difficult and non-responsive by most investors.

The management team is notorious for its sarcastic, biting commentary in its 8-Ks (it doesn’t hold earnings calls, but instead accumulates written questions and sets forth answers in an 8-K a couple times per year), and while this was at one point respected by investors (when the stock was working), such an approach is not nearly as well-accepted when a company’s stock hasn’t worked for three years.

Still, the company’s defining characteristic is its emphasis on long-term growth and compensation policy, which aligns employees’ success with the company’s shareholders.  Specifically, approximately 35% of compensation is based on operating income on a per office basis.  Additionally, employees are empowered and encouraged to make real-time decisions pertaining to pricing and cost controls based on local, customer or carrier specific dynamics.  This emphasis on performance and decentralization has served the company well and should continue to do so for the foreseeable future.

Risk Factors

Continued slowdown in global shipping due to further “insourcing” or macroeconomic factors

Asia-specific challenges/slowdown

Region or trade-lane specific competition

Retirement of key executives in a culture-driven company

Imprudent capital allocation