FedEx (FDX) reported results which brought some comfort to investors during a week in which markets were still in turmoil. While shares are down a third from the high of $165 in February at $110, and have lost more than half their value from the highs in 2018, shares have seen a rebound from an intra-week low around $90.
Shares performed relatively well over the past week as investors recognize that the company will see headwinds, yet the actual turmoil caused by the Coronavirus makes that the company might be a beneficiary of this to a smaller extent as well. After all, traditional just-in-time supply chains have come to a standstill making (additional) transportation required, notably for the international express unit. Furthermore, the company might benefit from social distancing and thus more e-commerce orders as well, as this pandemic might actually accelerate e-commerce sales.
Nonetheless, investors should brace themselves for negative surprises as the company is suspending the 2020 earnings forecast and is focusing heavily on cost-cutting opportunities.
The Numbers
FedEx reported third quarter results which ended the quarter on the final day of February. The only bright news is that sales were up 3% to $17.5 billion. Growth has been driven by the Ground segment with most other segments posting relatively flattish sales results.
Margins did take a beating as reported operating earnings fell exactly by half a billion to $411 million. The reason for the depressed earnings is that costs were up quite a bit. Salaries, purchases transportation, rentals and depreciation expense each rose between 5-10% year-over-year. This made that margins fell to just 2.3% of sales.
With net earnings of $315 million, reported earnings per share fell from $2.80 per share to $1.20 per share. Even if we exclude TNT integration costs, adjusted earnings fell from $3.03 to $1.41 per share.
For the first nine months of the year, GAAP earnings fell from $9.41 per share to $6.17 per share, as the current performance is arguably not indicative for the potential of the business. More important is the strength of the balance sheet heading into these challenging times. The company holds about $1.8 billion in cash, offset by $19.3 billion in debt, resulting in a $17.5 billion net debt load, which kindly excludes billions in post-retirement liabilities as well. That causes some potential overhang, although it all depends on the extent and deepness of the downturn.
The Potential
In June 2019, FedEx reported its fiscal year results for 2019, with the earnings numbers being a bit complicated as well. Adjusted earnings came in at $15.52 per share, with GAAP earnings only totaling $2.03 per share. The vast majority of the huge discrepancy results from retirement plans accounting adjustments, as well as TNT integration expenses, and some other expenses. The company generated nearly $70 billion in sales that year on which it reported adjusted operating profits of $5.2 billion and EBITDA of around $7 billion.
Problematic is that EBITDA will fall quite a bit this year, making that leverage ratios increase quite a bit, as cash flow conversion is an issue given that this is a capital-intensive business, with the company investing more than depreciation expenses currently come in at. That being said, in this environment the company might easily defer or suspend some capital investments to preserve cash flows.
While transportation is a cyclical business, truth is that FedEx is somewhat insulated thanks to more shipments going through its e-commerce network and international freight network. This might provide some relief and allow the company to withstand the pressure on the balance sheet, although it could become challenging times.
In the summer of 2018 I last looked at FedEx, which reported solid growth at the time. Fast forwarding nearly two years in time, net debt has increased about $4 billion over the past two years, while EBITDA metrics already have come under pressure amidst slower worldwide economic growth, challenges with the TNT integration and the significant pension issues.
Shares traded around $240 at the time as FedEx was doing very well. Amidst the slowdown in economic growth and some self-inflicted issues, margins and shares have taken a beating, thereby pushing up leverage ratios a bit. This is a concern with the coronavirus crisis now arriving.
Based on the leverage employed and large underfunded pension liabilities, I never think that FedEx should trade at a market multiple. In good times the company could earn $15-$20 per share and good times might return after the current events are over, as such potential future achievements might justify a $250-$300 per share valuation once the economy is back on its feet. For now the question is if FedEx can weather the storm unharmed. That’s without incurring dilution or other risks or expenses to shareholders.
Nonetheless, the good thing about FedEx despite the long-term potential is that some parts of the business might do well in these circumstances. Hence, I see appeal here around the $100 mark as a true long term investment based on the potential for shares to trade at much higher levels in the future.
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Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in FDX over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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