FedEx (NYSE:FDX), one of the world's largest shipping companies, has a 17-year streak of annual dividend increases going. In recent years, it has hiked its quarterly payment in June, but it didn't do that this time around. It held the dividend steady, at $0.65 per share per quarter. Dividends are not only a way for management to return value to shareholders, but also signal its opinion about the future prospects for the company. Should investors be worried about FedEx and its dividend today?
This streak ain't really over yet
The first thing that investors should understand about FedEx is that its dividend announcements are made to coincide with the company's fiscal year, which ends in May. That's why the June expectation for a dividend hike exists. This historical norm makes tracking calendar-year dividend increases a little bit different for this company than others for which the fiscal year and calendar year align.
In this case, even though FedEx has chosen to hold the line on its dividend, total dividends paid in calendar year 2019 are in line to be higher than total dividends paid in 2018. It's simple math, since calendar year 2018 included one $0.50-per-share dividend. So 2019 will increase the annual streak to 18 years as long as the company doesn't cut the dividend, which is highly unlikely. In fact, the streak won't be in jeopardy of ending for roughly another year at this point.
It's also worth highlighting that this isn't the first time that FedEx has used this mismatch between its fiscal year and calendar year to give itself a little breathing room. In fiscal 2009 and 2010, it paid the same $0.44 per share per year in dividends. But because of the timing thing, its calendar-year streak continued right along.
But what's going on?
All of this is nice, but it doesn't help explain why FedEx's board would choose to not increase the dividend like it has in the past. And, yes, there is a troubling reason for the choice. In fact, there are a few troubling reasons. First, FedEx has been having difficulty adjusting to the rapid increase in online shopping, with holiday shipping surges overwhelming its system in recent years. It's not alone -- peers have been taken by surprise as well -- but not living up to customer expectations is a big problem.
That leads to the second reason behind its dividend decision: The only way for FedEx to improve its service is to spend money. It basically needs to upgrade its operations to remain competitive. Spending has been elevated for a few years at this point, pushing free cash flow into negative territory. Capital spending in fiscal 2020, the current fiscal year, is expected to be nearly $6 billion. That suggests another year of negative free cash flow. Debt has been helping pick up the slack, with the company's debt-to-equity ratio increasing from around 0.3 to roughly 1 over the past five years. Although the acquisition of TNT Express in 2016 also helped to push that figure higher, capital spending outstripping free cash flow is now the issue to monitor.
Adding insult to injury, Amazon.com has been building up its own shipping capabilities to better serve customers. That's pushed retailers throughout the world to up their own logistics systems and delivery expectations. One effort has been to place products closer to key regions so shipping times are materially reduced. That, in turn, has put pressure on the shipping rates that companies like FedEx can charge. And FedEx recently made the decision to stop working with Amazon (which accounted for less than 2% of its revenue), so there's an additional headwind to face in fiscal 2020. Meanwhile, it is still integrating TNT Express, a large acquisition that, frankly, hasn't gone particularly well so far.
All in all, it shouldn't come as too much of a surprise that the stock is down around 40% from its January 2018 highs. But none of this suggests the world is ending. For starters, FedEx is working to adjust with the times. While that spending will hurt over the short term, the company has a long track record of successful execution. There's no reason to doubt its ability to adjust with the shipping market. That market, by the way, continues to grow along with the growth in online retail sales. Yes, some specific global regions have been weak lately (partly due to global trade tensions and economic uncertainty), but U.S. volume shows no signs of contracting.
And while investors need to monitor FedEx's leverage, it is hardly at a troubling level at this point. Competitor United Parcel Service (NYSE:UPS) has a debt-to-equity ratio above 6. FedEx can afford to lean on its balance sheet a little bit to upgrade its systems and continue to support its dividend while it's adjusting to better serve customers.
Read the signal, but don't get too scared
FedEx is definitely dealing with a number of troubling trends, and investors do need to be watching the company closely. In fact, the decision to hold the line on the dividend is an indication of the significant impact these issues are having. However, FedEx is still a financially strong company with a robust and growing business. Long-term investors shouldn't jump ship -- management deserves a little more time to put its plans in motion.