Expeditors International of Washington Inc. (EXPD) is one of my long-term holdings. It has enjoyed very good returns and is suspected (by me) of having a moat around its business, see here for more.
In this article, I wanted to update readers on its Q2 performance and management commentary, as developments were somewhat surprising. The latest quarter, of course, was a very unusual quarter in all industries. Most of the world was shut down for some portion of the 3-month period; a lot of volatility in earnings is to be expected and some sectors have been impacted in unexpected ways. One of Expeditors´ businesses is a case in point.
Second quarter performance:
As a quick recap, the company operates its business in three segments, i) airfreight services, ii) ocean freight services, and iii) customs brokerage. It operates as a non-asset carrier in its freight services, meaning it does not own any planes or ships. Instead, it buys bulk space from carriers and then resells the space to its retail clients.
Earnings for the quarter were up 20%, a more modest 5% when considering the first six months of the year vs the first semester of 2019. The driver of better earnings in Q2 was significant outperformance in its airfreight services division.
Airfreight was the star of Q2. In terms of revenue reached during the quarter, the segment had sales of $1.4 Bln. This amount almost exactly equals the level of revenue for the first six months of 2019. That is, the company managed to make two quarters worth of sales in the April to June period.
Source: Company SEC filing 10-Q
This is what Management had to say about Airfreight:
In the second quarter of 2020, airfreight services experienced unprecedented events in response to the global pandemic. As a result of travel restrictions and lower passenger demand, airlines cancelled flights reducing available belly space for cargo at a time where global demand for time sensitive delivery of essential PPE, medical supplies and technology equipment spiked. This caused extreme imbalances between carrier capacity and demand, principally on exports out of North Asia. In order to execute and meet the urgent transportation needs of our customers we heavily utilized charter flights and purchased capacity in advance and on the spot market, which resulted in historically high average buy and sell rates.
Expenses were also about $1 Bln, similar to expenses for the first semester of 2019, meaning the gross margin (of $400 million for the quarter and semester) was not sacrificed to achieve higher revenues. This was demand driven event.
The rest of the earnings report was softer – as expected – with about 10% drop in revenues for the other two remaining segments.
Near term outlook for airfreight:
When thinking about the short and medium term outlook for this segment of Expeditors business, the following questions come to mind: Was the performance in Q2 a one-time thing? Will such performance be sustained for a few more quarters? What underlying factors may have caused it?
A few days after reading this report, I came across David Einhorn´s letter for Greenlight Capital clients. The hedge fund manager, a notorious value investor (who has recently underperformed together with practically all remaining value managers – but is still one of the all time greatest business analysts) noted the following new position for the quarter (describing his new position on Atlas Air Worldwide Holdings, Inc. (NASDAQ:AAWW), an airfreight carrier):
Prior to COVID-19, approximately 50% of global airfreight was carried in the belly of passenger planes, mostly on long-haul international flights. With long-haul international passenger traffic down more than 90%, year-over-year (and likely to be the last segment of passenger travel to recover), there is a historic shortage of airfreight capacity……Market shipping rates increased by more than 100% year-over-year in the second quarter and are expected to remain strong…
Clearly, Expeditors was in a good position to capture additional margin even without having to own the freighters. Most importantly, this seems to be somewhat of a hedge to lagging passenger traffic, and the pandemic in general. Most countries continue to see infection rates remain elevated into the fall and the longer that travel restrictions remain, the scarcity condition will not subside. Einhorn´s letter goes on to explain that passenger planes are not efficient in competing with dedicated freighters – which is intuitive, given their different cabin configuration and loading/unloading access points.
Conclusion:
The performance during the first semester, and the second quarter in particular, may have surprised even the company´s management. Just in January of this year, the company issued an earnings warning as its saw the effects of the shutdown in China during the fourth quarter of last year being a major headwind.
“We recognize that our revenue and earnings will be below prior-year results and analyst consensus estimates,” said Jeffrey S. Musser, President and Chief Executive Officer. “However, we do not believe this to be a business model/performance issue and instead believe it ties more closely to the business environment in which we are operating. The market conditions that appear to have had an impact on our results include slowing of various global economies, trade disputes, and a customer base that is taking advantage of a market that appears to be changing from a supply and demand standpoint.
Just seven months later, the situation looks a lot better. Furthermore, as air travel continues to be restrained, the tailwind on this segments should proved further support to earnings for the rest of this year. A truly anti-fragile characteristic of Expeditors I had not expected. Sometimes (or maybe at all times) it is better to be lucky than good.
Disclosure: I am/we are long EXPD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
