Key statistics: NZX:FRE
Closing share price 09.10.18: $7.620
52-week high: $7.640
52-week low: $7.580
Freightways plans to revert margins
One business we have admired for quite some years is NZ-listed Freightways Limited (NZX:FRE), which provides express package services throughout New Zealand, as well as information management and mail services.
Most of the company’s earnings and value is derived from its express package business, where it enjoys scale advantages and a favourable industry structure.
This positioning affords Freightways a good measure of earnings predictability, and while performance is indexed to the New Zealand economy, which will ebb and flow, earnings tend to rise steadily over longer periods.
More recently, the business has experienced some decline in margins, and while overall economics remain good, we were interested to understand the drivers of this and determine whether margins might continue to ease, or instead revert to the mean.
The main driver appears to be the strong growth in Business to Consumer (B2C) deliveries resulting from the uptake of e-commerce. Where previously almost all of the express package business was B2B, around 25% of its volume is now in B2C. The issue here is that Freightways estimates that it earns a margin of around zero on this part of the business.
In package delivery, it’s helpful to have a high route density. It’s far more efficient to send a full van out on a delivery run than it is to have the same van make separate trips to deal with infrequent deliveries.
The issue with B2C deliveries is that consumer addresses tend to be more widely dispersed than business addresses, meaning more delivery work (and cost) per package.
Management has plans to do two things to address this. Firstly, it plans to consolidate its delivery routes and timetables in consumer areas to better suit the nature of the work. We see this as a very sensible and achievable initiative, and one that should help bring costs down.
Secondly, it plans to change its pricing model to allow prices to better reflect the economics of individual jobs. Once again, we think this is entirely achievable.
While there are no guarantees, we anticipate that these improvements may well restore margins in the company’s express package business to prior levels. While the difference is not overly large, it’s one that we think the market may not be giving Freightways credit for.
In a market where most things are priced for perfection – or better – an expectation gap like that is nice to find.