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Morningstar | Tough Comparisons and Moderating Global Trade Temper Expeditors' 1Q Performance

Wide-moat global forwarder Expeditors International’s gross revenue grew 9% year over year, slightly behind our expected run rate as global trade on key east-west trade lanes (especially Asia-U.S. and Asia-Europe) slowed a bit more than we were anticipating. Net revenue was up 3%, also slightly shy of our forecast due to volatility in both sell rates (to customers) and buy rates for capacity. Robust customs brokerage business partly offset the shortfall. Relative to the same period last year, increased gross revenue came from higher ocean freight volume and solid customs brokerage and import services growth. Operating profitability (EBIT/net revenue) came in modestly weaker than we were expecting, probably because of some lost leverage from sluggish airfreight volume, though management continues to execute well amid a volatile environment for forwarders.

The time value of money since our previous update more than offset the softer-than-expected net revenue and margin showing; thus we expect to boost our fair value estimate to $61 per share from $60. Our midcycle revenue and profitability assumptions are mostly intact. The stock is trading in modestly overvalued territory relative to our long-term expectations for profitability and free cash flow growth, likely due to optimism over solid execution and strong growth in 2018. We expect Expeditors' growth trajectory to moderate in 2019 on tough comparisons and moderating global trade, especially U.S. imports. U.S. inventory restocking was quite robust in 2018 and importers pulled forward some freight ahead of potential 2019 tariffs. European imports are softening as well. We think Expeditors can post 5%-6% average annual net revenue growth over the long run as benefits from the network effect support share gains in a fragmented market. We are baking in a midcycle operating margin (calculated off net revenue) near 31.0%, which compares with 30.4% in 2018 and a five-year average of about 31%.

By segment, airfreight gross revenue fell 2% on 4% lower tonnage, partly offset by higher sell rates. This decline is partly due to tough comparisons (volume jumped 5% in the first quarter of 2018); last year, airfreight volume benefited nicely from solid U.S. GDP growth, healthy restocking activity among shippers (including some pull forward ahead of potential 2019 U.S. tariffs), and overall solid global trade. Those trends began moderating by year-end. Additionally, in recent quarters management has strategically become more selective on business as market conditions have shifted. Ocean gross revenue grew 9% on higher volume and sell rates; volume grew 6%. We suspect Expeditors grabbed ocean market share in the quarter, given that U.S. and European imports were up only about 1% year over year in the quarter. Customs brokerage and other services gross revenue expanded more than 20% on continued strength compliance management, transcon (multimodal delivery services), and warehousing and distribution business.

Expeditors' net revenue (gross revenue less purchased transportation) increased 3%. Net revenue growth came in below gross revenue growth because of gross margin (net revenue/gross revenue) compression on both air and ocean business stemming from volatility in buy rates paid to carriers, which are aggressively managing capacity to boost profitability. Expeditors’ operating margin (calculated off net revenue) declined 160 basis points to 28.7% due to lost leverage from lower airfreight volume and ongoing IT infrastructure investments aimed at salesforce and back-office efficiency. Even so, Expeditors remains by far one of the most profitable players in the global forwarding market.