Could Freightways surprise on the upside?

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 FRE’s earnings and value is derived from its express package business, where it enjoys scale advantages and a favourable industry structure. This positioning affords FRE 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 of time.

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 ecommerce. Where previously almost all of FRE’s express package business was B2B, around 25 per cent of its volume is now in B2C. The issue here is that FRE estimates that it earns a margin of around zero on this part of the business.

In package delivery, its helpful to have a high route density. It’s far more efficient to send a full van out on a delivery run that 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. Combine this with a pricing model that is a little bit “one size fits all” and you have a growing part of the business that isn’t working as it should.

FRE 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. Having spoken with management, 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, this is not rocket science, and we think is entirely achievable.

While there are no guarantees, we anticipate that these improvements may well restore margins in FRE’s express package business to prior levels.  While the difference is not overly large, its one that we think the market may not be giving FRE credit for.

In a market where most things are priced for perfection – or better – an expectation gap like that is nice to find.