📍TL;DR

Freight middleman Expeditors was one of the biggest beneficiaries of pandemic-induced supply chain snarls — but the benefits are ending quickly.
Fourth quarter results were unprecedented, by management’s own admission, and there are three more difficult compares ahead.
EXPD stock has held up reasonably well — but in a nervous market, that seems likely to change.
Long-term, the stock may well work out. In the near- to mid-term, however, a downturn seems almost inevitable.

The core concern with the short case for Expeditors International of Washington is that it’s a little too easy, and a little too obvious. Expeditors’ profits are clearly set to reverse — indeed they’ve already begun that process — yet the stock trades at nearly 13x 2022 earnings per share, and in fact above the average Wall Street price target.

source: Finviz.com

In this way, EXPD seems to mimic the market as a whole. We are in the midst of a regional banking crisis of some kind1, and yet the S&P 500 rose 1.4% last week and the NASDAQ Composite 4.4%. For now, being bullish when everyone is bearish seems to be holding.

But we’ve been here before, and not that long ago. In our very first post, just under a year ago, we called out the risks to the equity market, which were hardly hidden. (Indeed, we noted that there possibly was “a contrarian case for being bullish, simply because it’s so easy to be bearish.”) That was at the end of March 2022; in the month of April alone, the S&P 500 fell 8.8%, and the NASDAQ Composite plunged 13.6%.

Sometimes, it’s profitable to simply not overthink — and that advice seems to apply to EXPD at the moment. Shares clearly trade at a premium to any reasonable calculation of normalized earnings. Fourth quarter performance was stunningly poor. Wall Street expects earnings to decline not just in 2023, but in 2024 as well. That’s an enormously bearish sign given how incentives skew analyst forecasts toward the upside.

To be fair, this is a good business, and the longer-term outlook might be more positive than the bear case suggests. But in the mid-term, EXPD is set to show declining earnings in a market environment that seems exceptionally unlikely to tolerate those results until the business gets to the other side of the cycle. At some point — and maybe some time soon — this stock seems likely to break.

cargo ship on sea under blue sky during daytime — Photo by John Simmons on Unsplash

Introducing Expeditors International of Washington

Expeditors International of Washington is a global logistics and freight forwarding provider. The company acts as a middleman, providing access to freight services by acquiring shipping space in volume from direct carriers and then reselling that space to customers shipping goods. Carriers benefit from consistent demand. Expeditors’ ability to consolidate freight provides shipping customers better rates than they can negotiate individually — both because of the consistency of Expeditors’ demand as well as the ability to fill much more of the carriers’ cargo space.

In 2022, Expeditors’ total revenue was about equally split between airfreight (35%), ocean freight (38%), and customs brokerage and other services (27%). The latter includes the filing of paperwork, payment of duties, and arrangement of inspections for customers. Expeditors also offers ground-based services once intercontinental freight has been delivered, along with warehousing and consulting services.

Expeditors provides its services through a worldwide network, including 176 district offices. About 29% of 2022 revenue was generated in the U.S. — but the country accounted for more than half of operating profit.

The Short-Term Bear Case

That simple description alone suggests the core reason for near-term bearishness. Oceanfreight and air freight both saw enormous increases in demand during the pandemic, particularly in the key China to U.S. lane that Expeditors serves. As a result, by late 2021, massive backups at West Coast ports — notably the Port of Los Angeles — were national news. The time to ship goods across the Pacific doubled, and in response American retailers and manufacturers resorted to shipping by air.

All three of Expeditors’ business lines benefited as a result. Airfreight demand soared, often from companies with little or no experience using that delivery method. The need for expertise in ocean freight became paramount for companies trying to avoid paying the margin-compressing fees required for airfreight. Higher cross-border volumes boosted the customs brokerage business.

The financial impact was extraordinary. Between 2019 and 2021, revenue doubled. Operating income jumped 149%, which (along with some modest help from share buybacks) led EPS to soar from $3.45 to $8.37. The U.S. led the way with a 158% profit increase over the two years; thanks to growth last year, in three years earnings at home more than tripled.

But normalcy is returning to the supply chain, both in the U.S. and overseas. In November, after more than two years, the backup at the Port of L.A. finally came to an end. Not coincidentally, Expeditors’ performance in the fourth quarter fell off the table.

A Disastrous Fourth Quarter

Even as normalcy started to arrive, over the first three quarters of 2022, Expeditors' results held up. For the period, revenue still increased 22% year-over-year. Operating income rose 16%, climbing 8% in Q3 even as revenue stalled out (growing just 1%).

The core reason for the strength was buy and sell rates2. For the first nine months, sell rates in airfreight increased 25%; in ocean freight, 74% (to be clear, that’s seventy-four percent).

That followed airfreight sell rate increases of 28% in 2021 (plus a 26% increase in tonnage), on top of a 78% spike in 2020 (though tonnage declined modestly). In ocean freight, sell rates increased an incredible 151% in 2021 (containers were +17%) after a 13% rise the year before. In each case, buy rates largely kept pace, but Expeditors still benefited by charging a spread on a sharply larger pool of revenue.

By Q3, that higher revenue was coming despite lower volume. But in Q4, both rates and volumes collapsed. In the Q4 release, Expeditors chief executive officer Jeffrey Musser was quoted as saying “the rapid turnaround in Q4 was stunning and unparalleled.” In the quarter, per the 10-K, sell rates fell 37% in ocean freight forwarding and 38% in airfreight.

As a result, revenue declined 36% year-over-year, and operating income 47%. Those results badly missed analyst expectations. The revenue decline was nine percentage points worse than the Street forecast; EPS of $1.38 missed by $0.59. Yet shares fell just 5.6% on the release, and have actually gained about 1% since.

Looking To 2023 (And 2024)

We’ll get to the market’s relatively calm reaction in a bit, but it’s worth first considering what Q4 2022 means for the near-term outlook.

The problem for Expeditors is twofold. First, there’s essentially no argument that the quarter was a one-off, or that the trend is going to reverse. Rather, the trend is simply a multi-quarter return to normalcy.

Again, the company’s own CEO was quoted in the press release as calling the decline “unparalleled”. In the same release, the chief financial officer cited [emphasis ours] “a rapid reversal from the most robust operating environment we have ever seen.”

The second problem is that Expeditors has three difficult comparisons on the way. In Q1 2022, for instance, revenue was up 131% against Q1 2019, and operating profit +146%. As a result, 2023 results are going to look ugly. Right now, analyst consensus models a 29.5% decline in revenue for the full year, with EPS plunging to $5.45 against $8.26 in 2022.

What’s somewhat fascinating is that the Street sees further, if modest, declines in 2024 as well. And this makes sense for one key reason: the U.S. market was so instrumental to the soaring profits seen between Q4 2019 and Q3 2022. Again, operating profit in the geography more than tripled. And the real problem for Expeditors is what U.S. profit margins look like.

In 2022 (with a soft fourth quarter), operating margins in the U.S. were 20.2%. In the rest of the world, they were 6.9%. That relative strength provided a benefit on the way up, with U.S. ports stacking containers and U.S. consumers buying (almost literally) whatever they could get their hands on. But the reversal of those trends amplifies the margin impact on the way down.

There’s probably some room for Expeditors to cut costs. The company was hiring aggressively through the summer, in part because of a massive cyberattack last February. The company did write in an 8-K3 in late August that “we will always fall on the side of protecting our employees even in downturns.” At the time, however, (in part because of the cyberattack), it wasn’t clear how steep the downturn was going to be.

Still, even with some level of operating expense reductions, it seems unlikely that operating margins are going to hold up, particularly with the recent outsized contribution from the U.S. (Expeditors, which has compensation that is notably heavy on incentives, may also have some issue in terms of resetting the base for remaining employees.) On the top line, meanwhile, it seems at least possible that Street models are still too bullish. 2024 revenue consensus, for instance, still suggests a 41% increase from the 2019 base, or annualized growth of roughly 7%.

The Case For A Short

One simple reason for shorting EXPD here is that, at some point, the stock should give way to at least some extent. In any market, posting three straight quarters of likely 40%-plus revenue declines is going to lead to weakness.4 In this market, which seems to have the potential for a steep decline (would a repeat of April 2022 in April 2023 truly surprise anyone?), the weakness could be severe.

But taking the longer-view, there are concerns as well. Against that 2024 consensus, and even excluding cash on the balance sheet, EXPD trades at about 18x earnings. That’s not a bad multiple, historically speaking: Expeditors posts high returns on invested capital and some investors for now might see the 2024 results as something like a trough.

We’re skeptical that is a trough, however — or close. Again, consensus suggests a 7% annualized increase in revenue (and net earnings) between 2019 and 2024 for a business that grew at almost exactly that clip (6.9%) across the entirety of the 2010s. Though 2019 did see some weakness in rates (and turmoil due to the trade war), that decade on the whole actually was rather positive for Expeditors. Shipping out of China and Asia grew amid a boom in consumer electronics, post-crisis macroeconomic performance in the U.S. was reasonably solid, and inflation was exceptionally mild.

Those conditions are not guaranteed to hold over the next two years. Taking the longer view (which investors of course will do this year and next), there are concerns beyond the cycle.

One obvious issue is competition. Privately held Flexport is trying to reinvent the freight forwarding model, and has had some success. The company raised capital at an $8 billion valuation early last year, and its founder earned a cover story in Forbes around the same time. According to that story, Flexport generated $3.3 billion in revenue in 2021, up nearly 5x from 2019. Germany’s Forto Logistics, which is targeting the China-to-Europe model, raised at a $2.1 billion valuation a year ago.

Closer to home, rival C.H. Robinson Worldwide , long a disappointment, might be getting its act together. That company is facing off against an activist investor who wants the company to sell its international forwarding business, but also has replaced its CEO after a period of rather stark underperformance:

source: YCharts

But another issue is the nature of cross-border trade more broadly. “Reshoring” and “deglobalization” have become buzzwords. Both trends would work against a company that earns its profits via a spread on cross-border trade.

The simple case against the short-term bear thesis — that shorting a plunging business probably works out at some point — is that investors are going to take the long view. What strengthens the bear thesis is that even the long view looks a bit cloudy at the moment.

Why Not Look Elsewhere?

An admittedly stronger argument against EXPD is that there might be better options elsewhere. Dozens of industrial stocks have similar short theses based on a retreat from peak profits, and with much worse balance sheets. (Expeditors has ~$13 per share in cash on the balance sheet, and no debt.)

Within the space, CHRW has disappointed in recent years, as noted, and its balance sheet has a bit more leverage. European peer Kuehne + Nagel $KHNGY has a roughly similar valuation based on 2022 EBITDA (K +N is a little less than a turn cheaper) but serves a more challenged economy in Europe. Europe plus the Middle East, Africa and India accounted for ~11% of Expeditors profit last year; K+N got 40% of earnings from EMEA alone. That European peer, meanwhile, saw roughly the same results in Q4 as Expeditors, with operating profit in its Sea Logistics segment down 42% year-over-year and Air Logistics off by half.

Meanwhile, a thesis based on the broader market rolling over has a plethora of options to choose from. As we’ve argued repeatedly, there are an awful lot of stocks down 50% (or much more) from the highs which still don’t look cheap. Many cyclical names have caught a bid this year despite building signs of macroeconomic risk. More simply, an investor could just short bad businesses — which Expeditors is not.

But there is some logic to a short here. Both CHRW and KHNGY benefit from ground logistics business which might actually hold up well in the near term. (K+N, for instance, saw growth in both that business and in its warehouse offering, though both businesses are much smaller.) Analysts in fact expect Robinson to post profit growth in 2023, and we’re loath to bet against the turnaround potential there at what appears to be a similar valuation to normalized(ish) earnings.

Moving outside the space, there are definitely opportunities for bigger swings — but that cuts both ways. The upside risk in a leveraged business that defies gravity (or benefits from, say, an inflation reading that's seen as bullish) is much greater. The first few weeks of this year in particular showed the risk in shorting bad businesses5.

In contrast, what possibly drives EXPD materially higher? A 25% move would put the stock at an all-time high. There’s almost zero chance the business shows growth until the Q4 release eleven months from now, and even that’s not guaranteed.

No, this is not a big swing — but this market, right now, doesn’t look like fertile ground for big swings. That kind of short requires correctly timing not just the underlying business in a period of unprecedented volatility, but the reaction of a market that in recent months has consistently zigged when history suggests it would zag.

In this kind of environment, trying to find 15% to 25% downside with muted upside risk seems an attractive trade. And that kind of asymmetry is out there. Right now EXPD trades around $106. Simply moving to the average Street target suggests EXPD would drop about 7% and a mid-teen multiple to current FY23 expectations (plus cash) gets the stock to $95, an 11% gain. Alternatively, a 20x multiple to the 2019 base (against the current share count and again plus cash) puts the stock at about $88, near our 20% target. Pull expectations down after an ugly Q1, or see mid-term risks surrounding inflation/reshoring/competition arise, and the downside can be higher.

EXPD is not the most scintillating short case out there. But with essentially zero cost to borrow, a little bit of liquidity in the options market6, and seemingly manageable upside risk, there's at least a solid case to short it here.

As of this writing, Vince Martin has no positions in any securities mentioned. He may initiate a short position in EXPD this week or in the near future.

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1

The parameters, depth, and importance of that crisis admittedly are up for debate at this point. But we just saw a $30 billion rescue plan led by the nation’s largest financial institutions. “Crisis” seems like the appropriate term.

2

Buy rates are what Expeditors pays to carriers; sell rates are what it charges to customers.

3

Expeditors doesn’t hold conference calls, but occasionally files an 8-K with questions submitted by investors.

4

One could posit an exception in a commodity stock whose realized prices have plunged, but in that scenario the stock no doubt would have fallen much further from its highs. EXPD is only down 20.6% from its all-time high, set in December 2021.

5

Among 1,900-plus stocks with a market cap over $2 billion, year-to-date Coinbase Global is the 4th-best perfomer; C3.ai 6th; and MicroStrategy 7th.

6

Interestingly, there is big open interest in two contracts: the May 100 put, where open interest covers over $10 million in stock, and the August 105 put.

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