ASX kingmaker stock upgraded to Wide Moat rating
WiseTech’s competitive position is incredibly strong and looks set to underpin formidable sales growth for the foreseeable future.
Mentioned: WiseTech Global Ltd (WTC)
We have reviewed the competitive positioning of WiseTech (ASX: WTC), the global leader in logistics software for international freight forwarding. We increase our economic moat rating to wide from narrow, due to a better appreciation of the uniqueness of the company’s switching costs.
WiseTech’s CargoWise drives significant improvements in the efficiency and efficacy of its users, as compared with alternatives, which, in the cost-conscious logistics industry, leads to consistent market share gains. Switching away from CargoWise is therefore not a rational decision.
CargoWise’s switching costs are most clearly evidenced by its annual gross retention rates, which have stood over 99% per year since 2013, despite WiseTech pushing through notoriously steep price increases over this period. The score warrants close inspection because it is exceedingly rare for software companies to have such near-perfect retention scores.
For comparison, WiseTech’s closest peers are estimated to have 95% customer retention rates. Although such scores are still very impressive, implying a mere 5% annual churn, CargoWise’s churn is at least five times better, at under 1% annual churn.
This assumes the difficulty level for retaining customers scales linearly between 95% to 100%, while in reality, the closer a company gets to 100%, the more difficult each incremental percentage point of retention becomes.
WiseTech and its customers outpace the competition
We believe WiseTech’s CargoWise software helps its customers meaningfully outperform their competitors and thereby reduces business failure risk to close to zero. We see this evidenced in several revealing metrics.
The most striking among these is that every long-term CargoWise customer that is publicly listed has seen its share price outperform every one of its publicly listed peers over the past decade by a wide margin, with the average CargoWise customer delivering around 10 times the share price performance of the average peer.
Figure 1: CargoWise’s publicly listed customers have outperformed peers. Source: PitchBook, Morningstar equity research, company filings, Armstrong & Associates Top 25 Freight Forwarders.
We believe this is because, by digitizing and automating processes, CargoWise makes its users materially more efficient (and effective) at their jobs. Anecdotally, we believe it is typical for freight forwarders using CargoWise to process twice the number of jobs per day, compared with the industry average.
But having twice the efficiency should result in half the staff, all else being equal. After all, as WiseTech’s CargoWise customers become proficient on the platform, they should be able to reduce staff and therefore have seat churn. This brings us to the second metric of customer outperformance.
We observe CargoWise customers have consistently gained market share, as they translate their lower cost base into lower prices for their respective customers, which, in a cost-conscious industry, results in significant improvements in their win rates at tenders. We believe the combination of a cost-conscious industry with an efficient market, and material efficiency improvements through CargoWise compared with all alternatives, means freight forwarders need CargoWise to be competitive in their industry.
This is different from almost all other software, which doesn’t significantly affect the success or failure of their customers – due to insignificant productivity gains compared with alternatives or because their customers don’t operate in industries which select as strongly for the lowest-cost provider. We have therefore described WiseTech as a “kingmaker” in its industry, as it essentially determines who succeeds or fails in the industry.
A different kind of switching cost
The kingmaker archetype of switching costs is different from most instances of switching costs. Usually, switching costs refer to a company incurring direct negative costs from switching to a different provider, such as having to train staff on a new system, integrating a new system with the company’s existing systems or risking disruption to mission-critical software.
CargoWise has those types of costs in spades. Customers typically take years to implement the mission-critical CargoWise software and we believe the same is true for subsequently switching away to another system. But we view the loss of benefits from higher productivity as far more significant in this case, as this affects a company’s core ability to remain competitive, and ultimately, to survive.
There are several important implications from WiseTech’s CargoWise customers consistently taking market share.
Most software companies primarily grow by increasing their number of customers, increasing user penetration within customers, increasing product penetration per user and increasing prices per product. However, WiseTech has an additional growth driver from helping its customers take market share and thereby growing their own businesses.
Moreover, whereas the traditional levers of software growth come with customer acquisition costs, customer success costs, product development costs or costs from increased churn, respectively, growth coming from customers taking market share comes with virtually no incremental costs in terms of sales and marketing, or research and development.
Still early days for market penetration
The market remains overly focused on the drama around the personal life of founder Richard White, which is distracting the market from the company’s large, and highly winnable market opportunity.
Although half of the world’s top 25 freight forwarders, and a quarter of the largest 200 freight forwarders use the software, we estimate still less than 10% of international freight forwarding volumes run through the CargoWise platform.
Moreover, this only refers to (air and ocean) port-to-port movements. WiseTech also has functionality for the next adjacent job, namely going through import/export customs and compliance, for which it is less penetrated. Given how tightly these two types of jobs are connected for freight forwarders’ workflows, we consider this opportunity as highly winnable.
The next job along the supply chain is typically the movement of a container between a port and a distribution center. Here the competitive intensity increases for WiseTech, as it starts to compete with the world’s many transport management system providers. But we do like WiseTech’s odds in this space over the long-term for two main reasons.
The first reason is sheer financial resources. WiseTech’s core international freight forwarding business generates large cash flows which the company can use to brute-force its way into the market, by either building or buying functionalities. The second is that these movements will increasingly have to pass through the CargoWise platform for the customs and compliance and air and ocean movements. Having an integrated system decreases the number of handoff points along the supply chain, which reduces costs and increases visibility.
We believe the next typical downstream movements of warehousing, and to-door and to-store are not logically adjacent enough in freight forwarders’ workflows to be winnable by WiseTech, as the supply chain typically has three distinct parts, moving goods from factory to a warehouse near the factory, moving goods from a warehouse near the factory to a warehouse near the consumer, and finally, moving goods from the warehouse near the consumer to the consumer (either to-door or to-store).
We believe WiseTech can also continue to expand along another dimension, namely toward the physical layer of the supply chain. We believe the company demonstrates network effects here.
Freight forwarders select and coordinate the operators of physical assets, such as ships, airplanes, trains, trucks, and warehouses, to move goods. When such third-party logistics companies are integrated with CargoWise, freight forwarders can maintain visibility as goods move along the supply chain without freight forwarders having to manually track and trace these movements. This results in significant labor cost savings for both the freight forwarders and 3PLs.
Given the cost-focused nature of the industry, we believe this incentivizes freight forwarders, who operate as gatekeepers in the supply chain, to give selection preference to 3PLs that are integrated with the CargoWise platform. Hence, 3PLs are incentivized to integrate with CargoWise to win business. This in turn increases the pool of potential 3PLs that freight forwarders can work with in a highly efficient manner.
Fair Value increased, shares look undervalued
We raise our fair value estimate to AUD 130 per share, from AUD 115 previously. At current prices, shares screen as materially undervalued.
We assume revenue grows at a compound annual growth rate of 20% over the next decade, driven primarily by organic revenue growth in the CargoWise product suite. We forecast an increase in group EBIT margins to 51% by fiscal 2034 from 37% in fiscal 2024, as a result of across the board operating leverage.
