FedEx (NYSE: FDX) delivered a quarter with disappointing results already announced a week earlier. This prior announcement led the stock to fall more than 20% in a single session. While management blamed the failure primarily on macroeconomic issues, investors and analysts seem to believe this is a company-specific issue. The call to analysts showed a high level of skepticism, and there are questions about whether the company can meet its 2025 financial targets set a few months earlier. Yet the stock is trading low at just 10x earnings, offering a huge upside if management can right the ship.
FedEx stock price
FDX previously climbed 20% after unveiling ambitious medium-term targets, highlighted by higher free cash flow prospects and a greater commitment to returning capital to shareholders. The stock has since given up all of those gains, and more. The stock has now generated minimal returns (excluding dividends) since 2006.
I last covered FDX in June, where I changed my rating from “avoid” to “buy” due to the aforementioned bullish outlook. Was I too early to make that judgment?
FedEx Key Metrics
In this latest quarter, revenue reached $23.2 billion, up 5.5% year-on-year, but operating income fell 15%. Non-GAAP earnings fell 21.3% to $3.44 per share. The company withdrew its full-year earnings forecast and guided the next quarter to flat revenue and a 47.5% year-over-year profit decline.
Perhaps the only bright spot is that the company has declared its intention to repurchase $1 billion of stock this quarter, which has allowed it to profit from the decline in the share price. Unfortunately, that was the only positive.
During the conference call, management indicated that the problems were mainly due to volume weaknesses related to the macro.
We have seen a decline in our volumes during the first quarter, which has accelerated in recent weeks. Our decline in volumes in Asia and the United States was mainly due to the economy, while the shortfall in Europe was both economic and service-related. Therefore, we had costs in the system for volumes that did not materialize. As we immediately took action, the savings from these cost reduction efforts were less than the decline in volumes due to the scale of our operations. As a result, while revenue grew 6% year-over-year, this momentum translated into lower volumes year-over-year across all of our transportation segments. Lower volumes had a direct impact on our results, causing the company’s total adjusted operating income to decline by approximately 18% year-over-year. (author’s highlights)
Management said that in response to the macro headwinds, the company is aiming to cut costs this year by up to $2.7 billion, of which about $1 billion of those cuts will be permanent.
Planned cost saving initiatives include the consolidation of sorting facilities in response to lower volumes. Management reiterated its cost reduction forecast of $5 billion by 2025, implying an additional $4 billion in expected cost savings on top of the $1 billion this year.
Is FDX stock a buy, sell or hold?
The stock is cheap here at just 10 times earnings, and the multiple gets even crazier when looking several years ahead.
Unfortunately, valuation is not the main issue as management execution has been questioned.
Analysts were highly critical on the call, even suggesting a new management team might be in order. I strongly recommend that potential investors read through the latest earnings call, as it was more candid on both sides than is typically seen.
On the conference call, management was asked why their peers hadn’t yet called out a similar weakness, but their response was to reiterate the macro headwinds and hint that others might possibly see the same weaknesses.
Analysts were unconvinced and began to implicate company-specific issues more directly. Take for example the following exchange between Brandon Oglenski of Barclays and CEO Subramaniam:
Hi, Raj and the team. Thank you for answering my questions. And certainly appreciate the new cost plans, but maybe we’re going about it the wrong way, because there’s been a lot of cost improvement plans in the past at this company that just didn’t measure up. So can I ask a pointed question? Have you done a product review, like what hasn’t worked in the past 20 years and caused your network’s profitability to decline compared to your competitor? Is there a certain product or customer or region that just isn’t working? And I can tell you from the outside looking inside, TNT seems to have been an absolute disaster here it just delivered, because you call European losses again. And then, from our point of view, as well as dual Express and Ground pickup and delivery networks, I get it. I know Express and Ground have different dynamics. However, your asset efficiency is literally half that of your nearest competitor, which is unionized, if I may add. So I guess, why not use this downturn to put more concrete plans in place to get out of markets or regions that aren’t working and eliminate the $1 billion in ongoing costs, obviously a step in the right direction. But I guess how can you fix the gaps in the network as you see them? (author’s highlights)
CEO Raj Subramaniam responded as follows:
Thank you, Brandon. I think we are absolutely committed to removing cost levers. We’ve talked about it in three installments: FY23, the $2.2 billion to $2.7 billion with — for the cost deduction here. We’re talking $4 billion between 23 and 25, then in Network 2.0 $2 billion after that. These are therefore significant figures. We are confident in these numbers. We have identified areas with targets. We have people who focus on business management and people who focus on business transformation. And we use cutting edge technology and some of it is already online here. And all of that is in motion as we speak to deliver value as quickly as possible. So we’re confident, we’re committed, and that’s definitely the whole team’s goal.
As for TNT, since you asked that question, you need to go back and watch the – a bit of history here. There’s a gap in our portfolio in Europe that our competitors have – has been in Europe since 1974 and it’s taken – it’s a very big business and a profitable business for them. We had to fill this gap in the portfolio. Did the integration go exactly as we expected? No because we had the cyber attack, we had COVID, we had all kinds of things in between. But the integration is now done, and the–that part is done. We had – service issues are getting better. And we have in our portfolio for sale in Europe which is unmatched and sales are growing. So that’s a starting point, if you could call it, and that’s why we’re confident in the improvements that Europe will bring us over the next 2 or 3 years. And again, on the Network 2.0 issue, it’s very easy to say yes, put it together and look at the numbers, yes, that’s great. But the complexity – from the point of view of technology, from the point of view of facilities, other issues is much greater. And most importantly, we have $4 billion in efficiency in the network that we can achieve relatively more easily than that. And by the way, we are building technology that will allow us to achieve Network 2.0. So we think it’s a good sequence.
From the outside, the response looked like a lot of excuses and little accountability. Other analysts tried to press harder to gain some kind of management ownership of the underlying issues, but to no avail.
What should investors do at this stage? Stock is still cheap here, but clearly my earlier rating needs adjusting. I previously rated FDX as a buy as a secular growth story. Crucial to the thesis was management’s apparent commitment to improving free cash flow generation and using excess cash flow to return cash to shareholders. But at this point I have to raise the risk profile because the execution of the management is again in question. Maybe emotions come into play here, maybe the issues are really macro related. But with so many other battered growth stocks available at attractive valuations, there’s no reason to keep pounding the table here. The obvious risk here is that management’s planned cost cuts prove unable to stabilize margins, which would further damage credibility and likely negatively impact valuation multiples in the short to medium term. It’s possible that FDX isn’t a secular growth story, but rather losing market share to competitors, although management said it was gaining market share in key markets. On the other hand, the valuation is compelling enough that a small position still makes sense here. Perhaps my multiple target of 15x earnings was too aggressive – but even at 10x to 12x earnings, the stock still presents up to 160% upside potential over the next five years. I view FDX as a buy, but investors should pay close attention to management execution in the coming quarters.