If its fiscal first-quarter report is any indication, Federal Express (FDX 1.54%) may have a difficult time reinventing itself in a brave new post-Amazon.com (AMZN -2.60%) world. Last week, FedEx announced earnings that fell short of analysts' expectations and also lowered its full-year 2020 outlook. The company cited disruptions related to the U.S.-China trade dispute, ongoing economic weakness and political uncertainty in Europe, increased FedEx Ground costs, and "the loss of business from a large customer." It doesn't take much of an imagination to read through the lines and understand that FedEx is already reeling from its breakup with Amazon.
Earlier this year, FedEx decided to cut ties with Amazon by not renewing its express shipping contract with the online shopping powerhouse. Just last month, management also decided not to renew the ground shipping contract. As Amazon continues to build out its own delivery fleet, pressure on FedEx to rise above the daunting new competition is mounting. While more time is needed to get a better judgment on the success of FedEx's strategy, the recent results didn't do much to give investors confidence in the company's ability to go it alone without Amazon.
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FedEx Targets New Retail Partnerships
To better compete against its former ally, FedEx is working toward establishing relationships with large brick-and-mortar retailers such as Target (TGT 0.51%). These relationships certainly have the potential to bear fruit over time. Target is experiencing tremendous growth in its e-commerce business, and FedEx stands to benefit from the growing volume of retail shopping done online. But several hurdles need to be cleared for these new partnerships to provide a much-needed boost to FedEx.
FedEx has embarked on a period of aggressive investment in ground delivery to meet heightened consumer demand for faster shipments, with heavy spending on technological advancements, including automation. Management has also been under fire for overspending on aircraft even as its express division has experienced weaker returns than the U.S.-consumer-supported ground division. The costs associated with all of these investments will need to dissipate before the benefits from any new retail partnerships become evident.
Management is also in the middle of integrating courier delivery service TNT, which it recently acquired to bolster its international business. This process has been moving at a snail's pace, and it's a thorn in investors' sides. In the third-quarter earnings call, however, management did reiterate their expectations of having TNT fully integrated into their operational network by 2021.
Spending Masks Removal of Low-Margin Amazon Contracts
As if the in-house challenges aren't enough, FedEx must also navigate a variety of external pressures, including the U.S.-China trade war and slowing global economic growth. Toss in the recent volatility in oil prices weighing on costs, and the company finds itself handling a big package of uncertainty that cannot be returned to sender.
FedEx has reached a fork in the road. Heading into the peak holiday season, it must quickly figure out how to address demand for rapid delivery while simultaneously healing from the self-inflicted wound caused by terminating the Amazon relationship. The company is cutting costs, but it's also ramping up investments, and those expenses will likely stay elevated through fiscal 2021.
Ultimately, management must choose a direction that puts the business on a path to improved margins and profitability. Shedding the high-volume, low-margin Amazon contracts should help with the former issue, and the TNT integration should also eventually show a benefit. The timeline on these events is uncertain, though, so near-term visibility for the company is compromised.
Is More Gridlock Ahead?
The market is losing confidence in management, and investors are getting frustrated with Federal Express. This may not be the end of the guidance cuts, and more downside in the stock seems plausible in the near term. FedEx has a lot of work to do to convince investors that it can successfully navigate the challenging economic backdrop and ward off competition from Amazon in the quarters ahead. One big step will be if it can show that new retail partnerships are gaining traction and improving its ability to overcome the loss of Amazon.
FedEx shares are currently trading at about 12 times forward earnings, a discounted valuation that is likely warranted given the recent performance and cloudy skies ahead. But the shipping stalwart is far too good a company to trade at this level for very long. Its earnings are likely at or near a trough, and the stock should eventually find an open road. Value-seeking investors may want to ride out the storm in the near term and await a potentially better entry point.
