At FedEx, The Pain Continues, And The Gain Isn't In Sight

There are two kinds of pain in this world," the actor Denzel Washington said in one of his films. "Pain that hurts, and pain that alters." Part of that quote could apply to the situation at FedEx Corp. FDX following weak fiscal 2020 first-quarter results. The pain of the quarterly numbers, and the dramatic reduction in the full-year outlook, certainly hurts. However, it is unlikely to alter much of the company's long-term plan.

There was no effort to sugarcoat the numbers, which were released after the market closed Sept. 17. The shipping and logistics giant posted adjusted earnings per share of $3.05, compared to median projections of $3.17 per share taken from a poll of 10 analysts on Barchart. Revenue came in at $17.05 billion, essentially unchanged from the year before. 

The full-year earnings outlook was the shocker. The company forecasted earnings of $10 to $12 per diluted share, or $11 to $13 per diluted share excluding the costs of the ongoing integration of TNT Express, which FedEx acquired in 2015 and which is still in the throes of a costly integration. In June, when it first telegraphed a sluggish fiscal 2020, FedEx said earnings per-share would decline by mid-single digits over FY 2019's level of $15.52 per adjusted share. In response, various analysts lowered their full-year forecast. However, even their revised numbers were well above what the company disclosed today.

The earnings outlook was revised further downward, FedEx said, because global macro conditions have weakened since the company's initial projections in late June, thus further pressuring revenues. Global GDP growth has dropped 20 basis points since last June to sit at 2.3%, according to the company's projections. That has been due to the impact of the U.S.-China trade war as well as a general slowdown in the Chinese economy, which has a knock-on effect on European nations that are huge sellers to China.

But the issues at FedEx were more than related to the macro environment. Revenues were hurt by the loss in August of Amazon.com, Inc. AMZN as a U.S. ground-delivery customer. The bottom line was hampered by higher than expected costs to build out its U.S. ground network to stay ahead of the e-commerce avalanche. The company has also spent about $900 million to modernize its global air express fleet in the face of low single-digit operating margins, a strategy that has left analysts like Amit Mehrotra of Deutsche Bank wondering where the increases in free cash flow will come from.

Shares were hammered in after-hours trading. As of 8 p.m. EDT, the share price was off about 10%, down more than $17 a share.

Mehrotra took FedEx to the woodshed in an after-earnings note, saying the company continues to blame its problems on macro forces and ignores the impact of multi-year missteps such as the slow progress on the TNT integration, the multi-billion dollar acquisition of reverse logistics provider, Genco, which by most accounts has not paid significant dividends, and "seemingly no relief" on capital spending, which will hit $5.9 billion in FY 2020 and be about the same in FY 2021. 

Mehrotra lowered his rating to hold on shares and cut his target price to $142 from $178. "While some may view this as the bottom in shares, we don't see any support until management takes responsibility for recent performance and clearly articulates a credible path to better results and cash flow (and delivers on it). In the meantime, shares will continue to melt lower, and rightfully so," he wrote.

Satish Jindel, founder and CEO of consultancy ShipMatrix and who has worked with and followed FedEx for decades, said the company needs to merge its high-margin ground and express operations into one unit, a move Jindel said would drive $3 billion a year to the bottom line by eliminating the high-cost, low-yielding flying business and focus on lower-cost and more dynamic ground services.

The biggest obstacle to that development, he said, is cultural. FedEx Express is the company's historic core, the mechanism by which it grew into a $70 billion a year colossus. Frederick W. Smith, the company's founder, chairman and CEO, would be loath, to say the least, to eliminate the brand. "They refuse to accept the fact that the natural-born child is no longer as profitable as the adopted one," said Jindel, a reference to FedEx's 1997 acquisition of Caliber System, Inc. that put FedEx in the ground delivery business nearly 25 years after its founding.

Smith, for his part, told analysts today that the units will not be merged, saying he is happy with the way they operate. He also took umbrage with the notion that his company is hard-headed and refuses to change. The fleet modernization efforts will yield enormous savings over time in operating efficiencies. What's more, 80% of the company's customers use its express, ground and less-than-truckload services (LTL). Cutting costs too deeply at one unit could hurt competitiveness at the others, he said. In addition, FedEx faces stiff competition across its three units, and must invest to remain competitive, Smith added.

In the U.S., the holy grail is to dominate the short-haul market supporting e-commerce deliveries. In that vein, Smith repeated his vow that FedEx will "unquestionably" be the lowest-cost U.S. ground-delivery firm once its network build-out is complete. In Europe, the FedEx and TNT Express physical networks should be fully integrated by the end of May 2020, the company said.

The company also took issue with the perception that it is a profligate spender on aircraft and that it can't let go of what got it here. The company is retiring 20 aging MD-10-10 and Airbus A-310 freighters, and it is parking capacity that is roughly equal to seven MD-11 aircraft. Despite the fleet modernization costs, FedEx will actually be retiring more lift than it is taking on, executives said.

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