FedEx Earnings Call Creates A Short Opportunity (NYSE:FDX)

NEW YORK (September 23) – Federal Express (NYSE:FDX) reported earnings and announced a cost-savings program earlier than expected today within about an hour after its stock price hit a 52-week low. The release raised the stock price up to the day’s high of $156.70 before settling down to close at $154.54. The stock was mostly flat in after-hours trading.

Why FedEx is struggling

FedEx warned last week that it was suffering what it described as “macroeconomic trends” that affected “global volumes…. both internationally and in the U.S.”, but warned that conditions had changed rapidly in the final weeks of the quarter. As we said last week, FedEx is dependent on the health and wealth of the larger economy and neither are particularly good at this point. Europe is expected to go into recession and is likely there already. Deutsche Bank said earlier this week it will expects a deeper recession in the euro area as a consequence of Russian halting Nord Stream 1 gas deliveries. It estimates GDP will drop 2.2% in 2023, with German GDP dropping as much as 4%. The euro zone recession is expected to have knock-on effects in Asia, its largest trading partner.

FedEx response

Cost Savings Having no control of the macro environment in which it operates, FedEx CEO Raj Subramaniam says the company “will focus on the issues that we can control in primarily on the cost side.”

FedEx reports on a June 1, 2022 to May 31, 2023 fiscal year and the savings discussed in yesterday’s earnings call relate to Fiscal 23. Overall, the company says savings will generate $2.5 to $2.7 billion, about $1 billion of which will be permanent. These plans include:

• a reduction in global flight hours, to include 11% of trans-Pacific daily frequencies, 9% of transatlantic daily frequencies and 17% of daily frequencies on the lane between Asia and Europe.
• improve FedEx Express ground efficiency, reduced routes, hours, vehicle rentals and other on-road expenses, such as 11% of routes in the UK and 12% in Germany.
• At FedEx Ground, select Sunday operations will be reduced at 170 locations.
• At corporate, plans are to close nearly 140 FedEx office locations and at least 5 corporate office facilities.

The company expects savings in each of the segments

• Express: $1.5 to $1.7 billion this fiscal year
• Ground: $350 million to $500 million
• Corporate: $350 million to $500 million

The company said it had realized $300 million in savings from these efforts in Q1 and expects approximately another $700 million in Q2 with the remainder of the fiscal ’23 savings to be realized during the second half of the fiscal year.

These planned savings are incremental to the savings from the FedEx DRIVE program, discussed more fully at the FedEx June 28 investor presentation. That program is expected to generate some $4 billion in cost savings by Fiscal Year End June 30, 2025.

Rate hikes

FedEx is raising rates 6.9% in January. It is also introduced a new remote area surcharge and peak residential pricing in the United States. In Europe and Asia, FedEx will launch a new handling surcharge as well in January. In August, FedEx implemented international fuel surcharge table adjustments for Asia, Europe, the Middle East and Africa.

Why FedEx plans won’t work

The company anticipates the Second Quarter will generate revenue of $23.5 to $24 billion. We believe that outlook is likely sanguine, as are longer term hopes for the following reasons:

1. Cost savings will likely fall short. Anyone who has been through a cost-cutting cycle knows how disruptive they can be to the overall business and that “reality” often fails to meet expectations. FedEx plans, including DRIVE, but especially the cuts discussed yesterday, seem to be reactive more than strategic, as would be realized by, say, a Zero Base Budgeting program. Moreover, as reported early this morning here on SA, and as raised by Deutsche Bank analyst Amit Mehrotra in yesterday’s call, those cost savings are likely to evaporate in an inflationary environment.
2. Management is understating macro risks. We expect volume declines to be sharper and longer-term, so that FedEx will suffer greater demand destruction than it anticipates. The central tendencies of Federal Reserve dot-plots released earlier this week support that view, as well as the anticipated decline in the euro area discussed above. We note, also, that the Russia/Ukraine war continues to escalate as President Zelenksy appears to be moving Ukraine’s agenda from defending Ukraine to punishing Russia for its aggression as part of a “peace agenda“.
3. FedEx premium pricing will evaporate. ShipMatrix reported that “the parcel industry dominated by FedEx, UPS, USPS and Amazon will face huge excess capacity during the peak (i.e., holiday) season of 2022, FedEx second quarter. Moreover, even SME businesses have access to ShipMatrix to optimize their shipping costs. FedEx has raised prices 6.9% previously, in 2008 and 2012 for example. But this “go to” rate hike, along with the other surcharges, ignores what will likely be a buyer’s market for FedEx services.
4. Local country shippers will add further margin pressure on FedEx premium pricing. FedEx faces margin pressure not only from UPS, but also foreign-based companies like Yamato Transport (Japan), DSV/AS (Denmark), Deutsch Post AG (Germany), etc., many of which have US locations or agents. These foreign-based shippers don’t need to price compete against a company with financials reported in “King Dollar”, currently the strongest currency in the G7. This currency based competition will likely grow worse if — as some expect — China devalues the yuan after the October CCP Party Congress. (SA commenter pg99, who says he lives in Thailand, reports that goods he formerly received from Amazon (AMZN) via FedEx now come via Shunfeng, a Shenzhen, China.)
5. Cost-reductions will likely cause service issues. According to Logistics Management, FedEx on-time performance during the 50th calendar week of 2021 was as much as ten percentage points behind its competitors, United Parcel Service (UPS) and the US Postal service. Cost-cutting, while obviously necessary, cannot help but disrupt customer service and risk customer satisfaction. Those issues compound significantly on the revenue side if UPS is first to restore its “money-back guarantee” that both FedEx and UPS dropped during the pandemic.

Summary

FedEx response to declining volumes and macro effects is to raise prices and surcharges and to, cut expenses, in management’s words, “control the things we can”.

But those efforts will likely disappoint. Between demand destruction and rising competitive pressures, and the service disruptions caused by FedEx drastic cost reductions, we foresee declining brand value and disappointing earnings for at least the next 6 quarters. We estimate the stock will move to $120 to $130 by the fall of 2023.

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Note: Our commentaries most often tend to be event-driven. They are mostly written from a public policy, economic, or political/geopolitical perspective. Some are written from a management consulting perspective for companies that we believe to be under-performing and include strategies that we would recommend were the companies our clients. Others discuss new management strategies we believe will fail. This approach lends special value to contrarian investors to uncover potential opportunities in companies that are otherwise in a downturn. (Opinions with respect to such companies here, however, assume the company will not change).