Analysis: could 2015 be a year to remember for sparkling Expeditors?

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If things go smoothly in the second half of 2015, US logistics company Expeditors will post a profit of about $450m for the full year – a level of net income 35% higher than its average between 2008 and 2014.

This comes in a year of tumultuous executive changes: chief operating officer Jordan Gates and Asia-Pacific director and co-founder James Wang both retired, following on from the retirement of previous chief executive and Expeditors architect Peter Rose last year.

So talk of a “management drain” in recent months was almost inevitable, but with Mr Gates replaced by a 28-year Expeditors veteran, Daniel Wall, one could argue that what is underway is more a generational transformation.

In fairness, the departure of Mr Rose was always going to be difficult to digest in terms of leadership, given the way his personality had been so clearly stamped on the organisation, rather than for equity investors and shareholders who must be very satisfied with Expeditors’ outstanding stock performance since mid-October 2014, which saw a 28% growth against a flat S&P 500.

Volatile trading conditions so far this year have surely favoured companies like Expeditors, whose financials are rock solid, and its reputation for being well-managed has not diminished since Jeffrey Musser took over Mr Rose’s job. Consider that its net cash position hovers around $1bn, while its free cash flow yield is north of 7%.

At the moment its shares are not far off their 52-week record of $50.08, a valuation that is only 10% below their all-time high and even looks a little pricey at 20-times forward earnings – which means that small details and market talk could change the complexity and the attractiveness of Expeditors if we were to look at it as an equity selection.

A possible problem is one of capital allocation – history shows that share buybacks seldom create long-term value.

Financials

Nonetheless, the first-half performance shows Expeditors hasn’t lost its sparkle, and it seems fairly certain that it will likely meet expectations at the end of 2015, which could be a year to remember.

However, the market may have doubts about a conservative capital allocation strategy over the long run, and any incremental rise in value from $50 a share might require an even steeper growth rate in earnings, yet its recent financials show that Expeditors is in good health on all counts.

Its most impressive financial growth rate in the first half was registered in earnings per share (EPS), both on a basic and diluted basis – which is hardly surprising. A strong operational performance has accompanied a capital allocation strategy dominated by buybacks (at between 7% and 10% of its total share count annually.)

During the three- and six-month periods ended 30 June 2015, the company repurchased 2.7m and 4.3m shares of common stock at an average price of $47.46 and $47.61 per share, respectively.

By comparison, the group said, during the three- and six-month periods ended 30 June 2014, it bought back 2.9m and 8.6m shares of common stock at an average price of $45.72 and $41.64 per share, respectively.

As a result of a higher stock price, buyback volumes have fallen, so it’s spending much less to shrink its share count, as you can see at page 5 of its half-year financial results (check out “financing activities” and “repurchases of common stock” in its cash flow statement.)

Weighted average diluted shares outstanding are down to 192.4m in the first half of 2015 from 199.4m in 2014, for a drop of 3.5%.

That’s smart – risk-adverse investors are providing support to its stock price, so Expeditors doesn’t need to deploy capital. It seems to me that the group is being cautious, keeping its firepower for a time when investors will place their bets on riskier assets.

One possible problem is that the more the shares rise in value, the more it’ll cost to reduce its share count, which may determine incrementally lower returns for its shareholders. At the same time, investors could look elsewhere for value if risk-on trades prevail.

Options

Diluted EPS rose 33% in the three- and six-month period ended 30 June, up to $0.62 and $1.17, respectively. The run rate for 2015 EPS is $2.34, which is bang in line with EPS estimates for the full year.

The first-half growth in EPS was backed by rising revenues, which were up 9%, net revenues up 14% and operating income grew 27% – all derived from its air and ocean freight forwarding services and its customs brokerage and distribution services, all of which are growing nicely.

Remarkably, the growth in its operating costs base has been outstripped – by two full percentage points – by the growth rate in its total revenues.

In spite of such a strong operational performance, the key question now is whether Expeditors’ management has anything else up its sleeve to deliver even more value to shareholders over the next few quarters.

As we argued in November, additional stock buybacks and a higher payout may end up being earnings-accretive solutions, rather than value-accretive options over the long run. Back then, we ruled out a takeover of the group, but we pointed out that its overcapitalised balance sheet could allow it to target inorganic growth via M&A, perhaps in the IT sector.

However, acquisitions do not appear to be high on its list of priorities. In a stock exchange filing last month, written responses to investor questions, it said: “We believe that ‘big and splashy’ acquisitions come with a great deal of risk including the amalgamation of cultures and people as well as the integration of systems.

“These items take a tremendous amount of time and work and tend to lead our management away from what is really important, our staff and customers.”