Expeditors International of Washington, Inc. (EXPD) Earnings Call Transcript & Summary

Hello, greetings, everyone. My name is Nick Beehler. I'm the Head of Business Performance and Technology for Onyx Strategic Insights. I'll be your host and your moderator today for our webinar. Thank you for attending. We have quite a large group, and it's an honor to have you here. This is our first webinar of the year, and we'll be offering a monthly series throughout 2024. Today's session is called Turning Point, an outlook for 2024. We'll be covering a range of topics from economic forecast to geopolitical shocks to consider and highlight of key elections and sustainability issues to monitor. Onyx Strategic Insights is a division of Expeditors formed in the last couple of years. One of our speakers, Fernanda will be giving you a bit more details about us shortly. You can follow us online on LinkedIn. And we published our different observations and updates on key areas regularly. You can also visit our website at onyxsi.com. Before we begin with the content, just a few administrative details to cover. At the start of the webinar, you're automatically muted and your cameras are turned off. We have about 45 to 50 minutes of content with Q&A mixed in during the session, and we'll leave some time at the end. On that note, you can submit questions in the Q&A box. You'll see that at the bottom of your Zoom panel. So just click that and enter your questions throughout. And like I said, we'll pause throughout to address questions. If we can't get to your question, we'll follow up after the event. At the conclusion of the event, sometime in the next 24 hours, you will receive a survey. We value your opinion and thank you in advance for filling that out. When you fill out the survey, you will get copies of the content, both the slide deck and the link to the recording of this event. Okay. Before we get started with today's event, I just want to put a quick little promotional word in. Next month's event is called Dynamics of Nearshore into Europe. We have two options: February 20 and 22, feel free to put your smartphone up now and grab the registration link for the event you would like to attend. And I will drop in the link in the chat here shortly, too, once I'm done speaking, so you can look for that there. And I'll show this at the end of the event. You can also follow us on LinkedIn where we announce events like this month's and next month's webinars. So we encourage you to follow us there. With that, I'm excited to introduce our 2 speakers today to get us started. First of all, we have Fernanda Kroup, the Vice President and Head of Onyx Strategic Insights. Fernanda has more than 20 years of experience in management consulting, geopolitics and macroeconomic analysis. She has lived and worked in 4 continents, serving clients and technology, heavy industries, basic metals, financial services, retail and consumer goods. A native of Brazil, Fernanda has earned a Bachelor's Degree in Law from the University of Sao Paulo and International Relations from the Pontifical University of Sao Paulo as well as a Master's in international affairs from Columbia University. Also with us today, we're honored to have Adam Karson, the Chief Economist of Onyx Strategic Insights. Adam has more than 20 years of experience as an economic adviser to global leaders across a range of industries. He has extensive experience in the U.S., Europe and Middle East. Adam most recently worked at Chevron as a senior economist, and he is responsible today for Onyx macroeconomic analysis and forecasting. Adam earned a Bachelor's Degree with Honors in Economics from Johns Hopkins University and a Master's in Public Policy from Duke University. With that, I will turn it over to Fernanda as the first speaker for today's event. So thank you, Fernanda.

Thanks, Nick. It's great to be with you here today, and thanks, everybody, for joining. Just wanted to give you a sense of what Onyx is. In a nutshell, we aim to help clients build more resilient, efficient and adaptive supply chains, and we do that by focusing on the geopolitical policy and economic disruptors. We are a consulting division of expeditors and so we took consulting engagement, supporting planning and risk management. And we're happy to engage and answer any questions you may have about Onyx separately. And so let me just dive into the content for today, which is our outlook for 2024. This is a big year for everybody. We thought we would separate out the certain and uncertainties, so our baseline views and the uncertainties. So all the geopolitical and policy items that can actually change the trajectory of macroeconomics and supply chains throughout the course of the year. So on the macroeconomic side, we still see a lot of that tug-of-war between growth and caution, right? Controlling inflation through monetary policy through interest rates, slow growth in 2024. We're more hopeful for a rebound in the second half of the year into 2025. But still, wages and raw materials at higher levels compared to pre-pandemic times. So a little bit of a tough situation here for businesses around the world, but some light at the end of the tunnel. On supply chains, mushrooming, sustainability requirements moving towards mandatory disclosure, but at the same time, a bit out of step with decarbonization efforts in country. So putting companies in a bind, really, in terms of their own stated goals and their progress towards those goals. Now on the logistics side, we see structural market changes and also, at the same time, bottlenecks at a time a notion of capacity glut. So a very interesting situation here on logistics and on rates. But then the geopolitical side comes along and you have the biggest year in elections. And we want to tell you a little bit about what to expect. Severe policy changes, not necessarily likely, but a lot in terms of changing existing policy environments to make countries competing with China, competing to replace China much more attractive. And then the U.S. being a little bit of an exception here, and we'll talk a little bit about it. But against this background, you have these -- this constant set of flareups and crisis going on, we call them geopolitical fault lines. Bigger impact contained for now, but a real sense of potential for escalation and how that impacts supply chains, we'll go into that. But probably the 2 main sources of risk this year to watch are the United States and China on a domestic level. Now we'll start with the macroeconomic side. I'm happy to pass on to Adam Karson, our Chief Economist. And once again, thank you for joining.

Thanks, Fernanda. Hello, everybody. As Fernanda mentioned, I'm going to walk through our global macroeconomic outlook for 2024 and even a little bit on 2025. And I'll also touch on some supply chain risks and opportunities as they relate to kind of the macro outlook. But let's dive right in. So as you all know, we've been on a bit of a roller coaster in the past several years following COVID with lockdowns, injections of massive stimulus, the knock-on effects of inflation, pretty resilient U.S. economy, but high inflation and high interest rates, driving a lot of uncertainty in addition to the myriad geopolitical risks that Fernanda mentioned and we'll talk about in greater detail. So a key question as we come into 2024, as we're still focused on many of these same issues is whether or not we're still on this economic roller coaster or are we finally going to reach a firmer ground? So one of our goals today is really to provide some context for how to think about these key economic themes and watch points, and overall growth for the next year. So I'll start with the big picture, which I think is 2024 is a bit of a tale of two halves, if you will, where growth is starting to decelerate and will decelerate the first half of this year, in particular, as the U.S. and EU feel the full effects of high inflation and high interest rates. But then as we get to the second half of the year, we're anticipating a modest pickup as we get into 2025. At the same time that the U.S. and EU are slowing down, we also see China's economy having reached a structural peak and the 5% growth that it achieved in 2023 is likely the fastest it can grow for any sustained period of time. And this is on the back of headwinds from the property sector, soft consumer confidence and some questions around the direction of economic policy, both short, medium and long term, which we think all of these things will preclude faster growth going forward. And of course, there's the looming risk of a larger economic crisis stemming from the property sector, which we think is not only the biggest risk to China's economy, but to the global economy as well. And so the numbers here that we present in terms of our growth outlook probably aren't that different than what you've seen with some other consensus forecast. So -- but there are some, I think, some important differences to point out. First is that we are, I think, marginally pessimistic on U.S. growth as we go into 2025. We do see a chance for a pickup, but we think the effects of inflation and interest rates will linger for some time. We also think that the EU is on the brink, if not already in recession right now. Certainly, Germany and Italy are quite weak and that's something that is a little bit underreported. And if you look at market odds of recession, I think they're understating the risk to the EU right now. And then on China, maybe less around the base case, but the scenarios that are presented on China tend to focus almost solely on these big sort of existential risks from the property sector and potential financial crisis. But we would argue that there's actually a range of risks and scenarios that not only lead China down a path of a sharp contraction, but maybe even a more likely scenario that leads to persistent stagnation and deceleration of growth even beyond what we're projecting in terms of growth going to 4%, we could see that even go -- decelerate even further for a longer period of time. And then digging into some of the details, we'll start with consumer demand. Our view on consumers is pretty commensurate with our top line view where we see the resilience of the U.S. consumer starting to fade, and that's being predominantly driven by some weakness in the labor market. We're starting to see some of those cracks form. Confidence is not as strong as it was last year. And then also the tailwinds, the things that were supporting growth and keeping it resilient in 2023 have largely faded away. And so we see growth decelerating to low 1 -- somewhere between 1% and 1.5% in the U.S. Similarly, we see growth among consumption in China, it's slowing as well. Decelerating after a decent rebound after it reopened from the COVID lockdowns in late 2022, early 2023. Japan is more or less steady as she goes. And Europe consumers look like they may be improving a little bit, but this is really on the back of a really weak 2023. So we have a bit of a base year effect. But all in all, we see among these major economies, consumers slowing down and momentum shifting to a slower trajectory. And if we look at the other side of the coin of demand, what's happening among businesses, largely the same trends, where companies' CapEx budgets are pretty tepid, and they're facing multiple headwinds again from inflation. So the cost of capital goods is quite high. And also, the cost of capital is high, of course, with interest rates having increased so much over the past couple of years. Now perhaps a bright side here is that when we think about the second half of 2024, if there's some clarity on the demand side, then businesses will feel more optimistic about spending at the same time that we anticipate interest rates starting to turn lower, which will significantly lower the cost of capital projects. So this is one area of optimism and one reason we think that growth could actually start to pick up in U.S. maybe around Q4 of this year driven by some pent-up business spending. And then underpinning this view and central to our global macro outlook is our view on global inflation and interest rates. And this is an area where we've held pretty steady on our outlook that inflation would ease and normalize by the second half of 2024, which would give some breathing room for central banks to begin cutting rates. And we see that in the market, the market is quite jittery and consensus has more or less kind of come around in this point of view but is still looking for any glimmer of hope that the Federal Reserve, in particular, could cut rates sooner than later. Inevitably, these kind of waves of optimism kind of come and go and then the market re-anchors around sort of midyear, June, July cut for beginning easing of interest rates. And that's kind of what we've held consistent to over the past 1.5 years. And so we're looking at the Federal Reserve cutting about 100 basis points on rates this year. The ECB could do something similar and perhaps even begin cutting rates sooner than later depending on the relative strength of the European economy. But as Fernanda mentioned, the level of prices is still relatively hot. So although inflation rates are coming down, the cost of labor and the cost of key inputs remain high by historical standards. We're certainly off the peak of 2022 when we had major market disruptions from geopolitical events. But we're not -- we have not returned nor do we think we're going to return anytime soon to 2018, 2019 sort of levels on prices. We do see some sideways momentum across many commodity markets, so that's perhaps a silver lining. But depending on what markets you're looking at, there might be some upward pressure as well. So in particular, things that are related to the energy transition, electric vehicles and infrastructure build-out that's being driven by a lot of industrial policy and infrastructure policy around the world. So I'm thinking copper and building materials will face, we think, upward pressure from this point forward. And then I'll wrap up this macro section with a little discussion on oil prices, which have albeit started off the year kind of in a bearish tone with a lot of uncertainty on the demand side and some resilience on the supply side, in particular, U.S. producers have outpaced market forecast. So prices, Brent Crude is below $80. We're thinking that an average price for the year will be in the low $80s, $80 to $83 per barrel, driven largely by a balanced view on fundamentals where demand is growing at 1 million barrels a day or so and a managed supply growth will more or less keep that market balanced where a lot of the growth is coming out of the U.S. and we anticipate OPEC to remain fairly disciplined and keep a floor under prices more or less where we are. Now I think the more interesting discussion here is, I believe the geopolitical risks, are all of the uncertainties that could push prices significantly higher or lower, in particularly, what we're seeing in the Middle East, right now and potential for spillover and a supply shock that could drive prices significantly higher. However, we should also note multiple downside risks that could be quite bearish for oil prices, in particular, a more dramatic kind of slowdown in the U.S., Europe and/or China and a breakdown of OPEC compliance. And Fernanda will touch a little bit more on some of these geopolitical risks that could really move markets in a significant way. Perhaps I'll pause there before we go on to the next section, and I can see if there are any questions popping up in the chat.

Yes. Thank you, Adam, that was really interesting. You talked about China, and you mentioned the property sector there. And then you read a lot about deflation, especially in the manufacturing sector and other numbers that might be worrisome for people. Using the term hard landing, maybe you could explain that too for the audience, like what do you see are the chances of a hard landing in China that becomes really disruptive for the global economy?

It's a great question. It's a kind of a perennial question as we've been doing this for a while. We've -- at least in my career, I've worked on China hard-landing scenarios pretty consistently for the past decade or so. And I think this time around, those risks of a hard landing are more significant than ever but still fairly well managed. Now the property sector is a major driver of growth in China. Depending on how you measure it, if you think about all upstream and downstream connections, you're looking at 30% of GDP connected to directly or indirectly the property sector, which is undoubtedly in a period of acute stress and stemming from years of overbuilding and excess capacity. And so you can't -- you don't want to understate the challenge that China faces in trying to deflate that situation, deflate the property bubble, if you will, and engineer a soft landing. But by our estimates, they do have the -- they have the financial capability and have a general transparency and knowledge of the situation that, I think, if we juxtaposed China today versus, say, the U.S. in 2007, 2008 or Japan in the late '80s, there are some key fundamental differences around the structure of debt in China's property sector and the political economy structure and ability for China to manage it. Now -- but just to kind of tie a bow around this, I think the risks are significant, but we think a greater -- sorry, the risk of hard landing are significant, but we think there's even greater risk that there's a prolonged slow deflation of the property sector with it sucking up more money than anticipated and it being a drain on growth for not only a short period of time, but, say, for the next like 5 to 10 years even. And that could take 0.5 percentage point or more off of our baseline view.

Awesome. Thank you. I think we'll end with that question and then allow you to move on to the next section.

Sure. Thank you. So let's move on to some of the things we're seeing in the supply chain world. In particular, around a lot of the hot terms you've heard: friendshoring, nearshoring, reshoring, China Plus One, so on and so forth. All of these are just different ways of saying derisking. And each strategy related to derisking depends on what companies are trying to -- what risk they're trying to mitigate, whether it's a particular geopolitical risk or proximity to demand issue, trying to get closer to their end consumers? And another common theme we see a lot is try to improve ESG, in particular, manage the environmental side of their ESG score, if you will. Now in addition to these kind of common themes around sources of risk, we should also note that as companies are thinking about mitigating some risks, these strategies imply new risks that will be embedded into their supply chain. So for example, moving a supply chain, moving sourcing from Asia to Mexico comes with a whole new set of challenges related to security, infrastructure, logistics performance that companies are only getting to kind of wrap their head around what that means for their supply chains going forward. And as companies are thinking about derisking, it's happening at a time when countries are using policy in a very direct way to compete for foreign capital. And this is just a snapshot of some of the countries we cover and the key policy areas that we focus on, including labor, industrial policy, trade, tariffs, infrastructure, taxes and ESG. And some common themes that we see pretty much across the board as countries compete for capital is the use of industrial policy to improve investment attractiveness of their domestic market. Typically, this is pretty focused and honed in on specific sectors, so whether it be autos in Thailand or consumer electronics in Vietnam; in the U.S., we see it with semiconductors in the CHIPS Act. And then also, we see this being paired with infrastructure policy to build out -- make sure that logistics capacity is going to keep up with new manufacturing capacity. Now not all countries are going to be successful at this. Even within infrastructure, often you need regulatory and process change to go along with more modern infrastructure. And so we're going to see -- we anticipate a divergence in performance across countries. And that's notwithstanding some of the backsliding we're seeing on labor and tax policy that is making some markets less attractive. And then to complicate this even further, as we move into this year and then in 2025, there is really a tidal wave of ESG disclosure regulations that are coming and the shift really here is -- there are a couple of shifts. One is from voluntary reporting to mandatory and then the increase in scope and transparency, in particular, including Scope 3 emissions in mandatory reporting and then it's double materiality assessment of moving from the old days of showing how climate impacts your business, but now showing how your business impacts climate and essentially opening up the door, opening up the windows to allow regulators and investors scrutinize company's actions to -- in particular, to decarbonize their businesses. And as we view this, this increased focus on decarbonization is happening at a time when many countries are kind of stagnating on their efforts to decarbonize their economies and in particular, their manufacturing base. And we think this is another point of divergence between some key economies you normally associate with sourcing. In particular countries, if you look at the ASEAN economies, countries like Singapore, Thailand, Malaysia, are investing heavily in renewable power, increasing their chances to be able to keep industrializing but in a more sustainable way, juxtaposed against countries like Indonesia, Philippines, Vietnam, that are laggards in the space. Mexico as well, once a leader, now a laggard on decarbonization. And this presents quite a challenge for companies in the context of their derisking strategies of how to think about balancing ESG risks and decarbonization in particular, with other key concerns around mitigating geopolitical risk, maintaining cost discipline, getting closer to your consumers and really trying to kind of uncover what your actual options are and what kind of capacity is out there in the market. So if you look at China, for example, making up nearly 30% of global manufacturing capacity, is relatively high cost compared to a lot of alternatives, if you look at total end of costs, but it performs say decently on carbon intensity, but there's a lot of room for improvement. However, the alternatives out of China are much smaller. Vietnam, for example, is 2% the size of China, to need 50 Vietnams to replace China, which obviously is not going to happen. So it forces companies to think very strategically and surgically at the same time about where exactly they would want to source from to balance this sort of trilemma even more complicated picture. So with that, Nick, I will pause again. Before we move on to the geopolitical side, see if there are any questions so far.

Yes. Maybe just a quick question for climate and sustainability. Are there any like signposts, whether those are like legislation, different programs that people should be looking out for or different regions that people should be looking -- whether it's Europe or U.S. in terms of where to look for sort of guidance in that area, whether it's reporting or just kind of new legislation? Anything people should be looking out for this year?

Yes, there are. So I mean, the leaders in this space are Europe and California. And so first, focus on where legislation is already -- regulations have already been passed. There are -- in California, I believe there's at least one Senate Bill and one House Bill related to climate disclosure -- ESG disclosures. And then in Europe, there's regulation in place. Now I think there will be some additional things this year to pay attention to. What does -- for example, what does the SEC do in terms of acquired reporting? And then also, I think there's still some question marks on how exactly companies are going to comply with reporting Scope 3 emissions. This is something that a few companies are doing. The data for Scope 3, if you think about all of the suppliers in your supply chain, the data is quite weak. And so compliance is going to be a pretty sticky issue and company should be engaged very proactively to manage that. You don't want to get to the end of the year and kind of caught behind the curve.

Awesome. Thank you for that. Great. So I think at this point, we'll turn it over to Fernanda for the Section 3 of the presentation. Fernanda?