This has been an unimpressive stretch of market performance for big freight forwarding companies like Expeditors International (Nasdaq:EXPD), Kuenhe + Nagel (OTC:KHNGY), and UTi Worldwide (Nasdaq:UTIW). Global trade has slowed pretty significantly, with major Asian air cargo terminals reporting scant (if any) growth, and likewise weak inbound freight figures for U.S. ports. In a roundabout way, maybe that's not so bad for UTi Worldwide, as this company tries to deliver on a multi-year turnaround strategy. If you're going to deliver uninspiring results, it may as be when investors aren't terribly keen on the sector.
Another Weak Quarter
Probably the best thing that can be said about UTIW's quarter is that the company only slightly missed sell-side expectations. It's also worth noting that business seemed to pick in April, though I'd say it's too soon to get excited about a big rebound.
Net revenue declined a little more than 7% this quarter, with company-defined “organic” net revenue down 3%. Freight forwarding revenue declined 8%, with net revenue down about 4%. Airfreight continues to see pricing pressure, as revenue declined 15% on a nearly 3% decline in tonnage. In oceanfreight, revenue was down slightly as a 5% increase in TEUs was offset by a similar decline in revenue per kilo. Contract logistics and distribution revenue was also weak, falling 9% from the year-ago period.
Profitability is still under serious pressure. There are a lot of items and adjustments in UTIW's reports, but I think the salient points are that organic adjusted operating expenses were about 2% higher this quarter and non-GAAP adjusted operating income declined 74%. Excluding corporate expenses, adjusted operating income declined 39%.
SEE: Zooming In On Net Operating Income
It's Down To Restructuring
The bad news for companies like UTi Worlwide, Expeditors, FedEx (NYSE:FDX), and UPS (NYSE:UPS) is that they're derived demand businesses and can't do much to stimulate real underlying demand. Sure, aggressive pricing and service expansion can shift share, but the actual underlying demand for cargo transport is out of their hands.
While UTIW could, I suppose, compete more aggressively on price, the real story here is the multi-year restructuring. This company has been talking about restructuring for a long time now, as the company's margins have badly lagged those of Expedtors and Kuenhe + Nagel due to a lack of coherent strategic direction and resulting inefficiencies.
UTIW has turned in part to Oracle (Nasdaq:ORCL) to help fix this, and the company is trying to implement a unified system to improve inter-office communication and global coordination. Significant labor savings are also built into the plans (upwards of $90 million in fiscal 2016). Unfortunately, UTIW has been talking turnaround for a long time, and Wall Street has grown skeptical and switched into “show me” mode. To that end, management's guidance that 70% of shipments would be on the new system by year-end was encouraging.
Can UTIW Really Close The Gap?
I'm concerned about just how much operating leverage UTIW can actually deliver. While the company is a top ten player in a very fragmented market, it has about half the market share of Expeditors, and about one-quarter of the share of Kuenhe + Nagel and Deutsche Post's DHL. As this company is playing catch-up in terms of its corporate systems and operating efficiency, these larger rivals are flexing their muscles and competing more intensely for business.
It's also worth noting that UTi's market exposures could continue to be problematic. The company generates a substantial portion of its business from South Africa (about 18%), but relatively little from China (7%) and all of Asia (including South Korea, Thailand, etc.) is only about 16% of revenue. I don't necessarily expect South Africa's currency woes to continue, but I'm not sure being overweight Africa and underweight Asia is the right ratio for global freight growth.
SEE: Earnings Guidance: Can It Accurately Predict The Future?
The Bottom Line
UTIW looks about half-way between the bull and bear-case scenarios. If management fails to close the gap on Expeditors in terms of operating efficiency and produce better cash flows, fair value would be in the neighborhood of $10. If management can close about 80% of the gap (at least in terms of free cash flow (FCF) production), a fair value of $20 is not unreasonable. That's enough upside to merit further investigation, but I personally have a hard time trusting a multi-year turnaround plan from a long-time laggard in such a cutthroat and low-margin business.
At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.