FedEx Falls, Pets Are Paying Off

In this episode of MarketFoolery, host Chris Hill chats with analyst Emily Flippen about some business news. FedEx (FDX 0.11%) shares tanked when delivery giant decided, without much advance warning, to stop sugarcoating some pretty big issues. Meanwhile, Chewy (CHWY -2.54%) released its first quarterly report since going public. Despite pretty good results, the stock sold off. Plus, General Mills (GIS 0.85%) reported that while the rest of its segments aren't doing so hot, its Blue Buffalo pet food is selling like hotcakes. Maybe some more pet food acquisitions are in the company's future. Tune in to learn more!

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on Sept. 18, 2019. 

Chris Hill: It's Wednesday, September 18th. Welcome to MarketFoolery! I'm Chris Hill. Joining me in studio today, she's not on Twitter, but she is here in the studio, Emily Flippen. Thanks for being here!

Emily Flippen: Thanks for having me, even though Twitter won't!

Hill: I think Twitter will have you. I get that question on Twitter every time you're on the show. "Where is she?" 

Flippen: Maybe I won't have Twitter. I'll put it that way.

Hill: There we go. We've got earnings. We've got pet earnings, packaged food earnings. We're going to start with FedEx. Technically, these are earnings, although fourth quarter profits for FedEx came in lower than expected. Their revenue was also down, and they cut full-year guidance. They didn't really hold back in terms of all of the challenges that FedEx is facing as a company. If you look at FedEx as a bellwether business, then there is cause for concern, because shares of FedEx are down 13%. This is the worst day in over a decade.

Flippen: Yeah, and FedEx is one of those businesses that tends to actually respond pretty significantly to changes in the macro environment. When they had this poor report, to put it nicely, there were a lot of things that they pointed to as contributing, one of those being the trade war and a softening macro environment. Another one being the recently severed ties with Amazon. Earlier this year, they canceled their contracts with FedEx for both ground and air shipping, to do their own initiatives into speedier delivery. 

What I thought was really interesting is, FedEx for a while has been a questionable investment just because they're spending so much money to invest their infrastructure. Clearly, there's some softening in their B2B, business to business, area, which is their higher-margin business line. In addition, the issues with Amazon. What I thought was interesting is, going back, they actually downplayed a lot of these things in previous calls, which is why this earnings report in particular was so big for them. A lot of Wall Street analysts as well were actually defending their positions. They were taken aback by it, saying, "Wow, they really misled us with how bad this could be moving forward." At the time, they said Amazon only made up about 1.3% of revenue. This earnings call, you'll see, they're using Amazon as a scapegoat for part of their performance.

Hill: Yeah, it's interesting, because Fred Smith and his team have been there a long time. This is a tough business to run. I think, in general, Fred Smith and his team have run it well. But, you're right, absolutely, about this quarter and the reaction in the investing community. There was a little bit of that, like, "Wait a minute!"

Flippen: "We knew it was bad, but not that bad."

Hill: Right. "This isn't what you've been saying in the past about Amazon." Also -- and this got a little bit of play; I don't think it's as significant as what you mentioned in terms of Amazon and the trade war and the macro economic impact -- you go back to the acquisition of TNT Express. FedEx really trying to expand in Europe. Now, with the benefit of a few years' hindsight, you can look at that and say, "You know what? That didn't go nearly as well as you wanted it to." Yes, there was a cyber-attack. Whether or not FedEx is to blame for that... even if you absolve them of blame in that situation, the case that they were making for acquiring TNT Express, the synergies that could be wrought out, how they could expand their gross margins -- that just hasn't happened. It really hasn't happened the way they wanted it to. And I think we're seeing today coalescing of a lot of negative opinions. Sort of the, "Wait a minute, that didn't work out the way you said it was going to. Now, you're telling us something different about Amazon." And I think for the first time in a long time, there's genuine skepticism about FedEx as a business.

Flippen: I agree. It's not to say that I think FedEx isn't going anywhere. I look five years now, and I do think FedEx is still going to be relevant, it's still going to exist as a business -- but it does call into question the capital decision-making of management, especially now that they're spending so much money to do stuff like modernize their infrastructure, something that they arguably should have done in priority over acquisitions. It does lead to a lot of skepticism from investors. 

But when I think about FedEx, while I don't think it's going to be a particularly outstanding stock over the next few years, you can't deny that they're good at what they do. This might be peak FedEx hate, especially if we don't enter a recession in the next, I'd say, six months.

Hill: Also, you think about the next few months going into the holidays -- if FedEx has a blowout quarter in early 2020, then this is a distant memory. We'll close on the stock. As I mentioned, down 13%. Worst day in over a decade. Are you interested at this lower price? Or, do you think there are enough question marks, some of which FedEx has raised, that you're not buying this value play option?

Flippen: Yeah, they've lost a little bit of trust from me here. Their new earnings expectations are about 20% below what they were just before they reported. This one report alone decreased 20%, which is still a significant year over year decline. I'm still not excited by this business, but I also don't think it's the doomsday scenario that some people may feel like it is today.

Hill: Alright, let's move on to Chewy, which is the pet food and products retailer. Chewy's second quarter loss was smaller than expected. They raised revenue guidance for the full fiscal year. Chewy's stock, down about 5%? Why is it down? I don't own the stock, but I just look at this and think this is what you would want to see if you're a shareholder.

Flippen: I'm not a shareholder yet, but I'm a big fan of this business. I was happy by their recent report. I feel like some of the market -- I don't want to call it "confusion" -- market response is twofold. First, this is their first report since becoming a publicly traded company. We've seen the market destroy a lot of these high-flying IPOs. It's not a terrible surprise, since they didn't completely blow out expectations, that the market responded the way it did. But, also, they posted a narrower than expected loss as long as you take out the non-stock-based compensation expenses. If you include that, it's actually a significantly bigger loss. I guess it depends on how people are perceiving the losses attributable to them as shareholders. Are they including stock-based compensation, are they not? Personally, when I look at these types of companies, which are still very much in the growth stage, I don't tend to add a lot of sway to stock-based compensation. But I can understand why investors do. Ultimately, Chewy is not profitable, so it makes sense that people, when they see that sticker shock of the first number, they think, "Is this company ever going to be profitable?" 

I'll give my quick, two-second Chewy pitch here. Chewy could easily be profitable if they just scaled back their marketing expenses. Chewy continuously shows that the lifetime value of the customers that they acquire significantly outpace the amount that they spend to acquire that customer in sales and marketing. The fact is, the company doesn't want to be profitable right now. In fact, if you're thinking about FedEx, thinking about some sort of pullback in the market, pet supplies tend to be pretty resilient when it comes to recessions. And Chewy by far has the biggest presence for online pet sales, and it's still really nominal, the number of purchases that are made online for pet sales in comparison to apparel or electronics. So there's significant room there for new customers to come into Chewy's atmosphere, for Chewy to acquire those customers. This year, they're projected to do about $5 billion in sales. It's a big, big business. It's not pets.com, as many old school investors might think. But it's an exciting company. They have active customer growth of 49% year over year. Gross profit margin improvement. Lots to like here. Personally, I see this pullback and I get a little bit excited. If I could just keep my mouth shut about the company, maybe I could actually buy some.

Hill: Is this a company that you think is potentially an acquisition target? I'm thinking of a couple of years back, when Blue Buffalo, which is in this line of business, was a public company, stand-alone. And General Mills came in and snapped it up for around $8 billion. Chewy, right now, valued around $11.5 billion. It'd be a little bit more that someone would have to pay for them. But if you're making up a list of reasons to buy this stock, is that on the list?

Flippen: No, not at all. 100% never going to be acquired. That's because the company was actually sold to PetSmart by its founder back in 2017. PetSmart now owns the vast majority of the business, virtually the entirety of the voting control of the business. And that's the single biggest risk with this investment. I was probably remiss for not mentioning it in my quick pitch earlier. Ultimately, PetSmart is a declining business. They're are an old school retailer and they're going to leverage their ownership of Chewy's to the best extent that makes PetSmart money, not investors. I don't think this is a company that PetSmart is going to ever consider selling to somebody looking to acquire it, simply because it's the only part of their business that is offering any growth opportunities.

Hill: Speaking of General Mills, back when they bought Blue Buffalo, that showed up in this first quarter report from General Mills. It was a mixed quarter. The pet division's looking pretty good. The snack bar division, not so much.

Flippen: Actually, pet food was the only division that saw any growth this quarter for General Mills. I think what investors were, I'm going to say excited about -- I think "excited" is probably an overstatement -- they enjoyed seeing that earnings still beat expectations. The fact that they reaffirmed organic net sales guidance for the year, 1% to 2%, although that 53rd week is definitely helping them out there to the tune of about 1%. So, even though they missed on revenue this quarter, I think the fact that there wasn't lower guidance was probably a good thing. That's why the market generally responded pretty positively. 

But, as you mentioned, it's really just pet food. That acquisition of Blue Buffalo for them was the single thing that's keeping their business afloat right now. Pet food sales grew about 7%. While pet food, I don't think, is the first thing that comes to mind when you think about General Mills, I definitely think it's framing the way that they're considering their business. Ultimately, pet food sales is about 10% of their business, which is almost as big as their entire Europe and Australia business, and bigger than their Asia and Latin America business. So the fact is, pet food has become a big part of their business. Softening demand on the North American retail side for things like cereals and snacks, those are the things that are really dragging down this business. It'll be interesting to see what they're thinking about in terms of restructuring their product. Unfortunately, in General Mills is a big company with a long history, and they tend to be slow to innovate.

Hill: Here's another thing that's not helping General Mills: the news this week that Gold Medal flour, which is one of their brands that they have, General Mills issued a recall for 300 tons of flour for potential E. coli contamination.

Flippen: That sounds terrible! But when you say that, I'm sitting here thinking, I don't think I could tell you how many three tons of flour is. Is that a lot of flour for General Mills? Is that a small amount? 

Hill: 300 tons.

Flippen: 300 tons. Well, it sounds like a lot. I will say that. Let's just hope this doesn't happen to Blue Buffalo.

Hill: Exactly. I'm not concerned about it, because when I bake, I use King Arthur. I have brand loyalty when it comes to flour and baking products. Here's another thing that surprised me, though. For the mixed quarter -- and you're absolutely right, pet food is not what the average person thinks of with General Mills; it's probably breakfast cereal -- this stock is up more than 40% year to date. This is not at all what I was expecting when I started looking into General Mills. It will be interesting to see, with all of the brands they have under their portfolio, and the success thus far of the Blue Buffalo acquisition, it'll be interesting to see what this company's brand portfolio looks like in, say, five years. It really wouldn't surprise me if they started looking to shed some of these snack brands, maybe not the breakfast cereal ones, just because I think they're so ingrained, and maybe that's a business that's essentially on autopilot. But it wouldn't surprise me if they started looking for more opportunities in the pet space.

Flippen: Yeah. And honestly, as somebody who has at least one bowl of cereal a day, I hope that they stay in the cereal game. They've kept it competitive. They kept options available to us cereal connoisseurs. But, I couldn't agree more that I would expect for them to really hammer down on the brands that are actually driving growth for the company.

Hill: What's your go-to cereal?

Flippen: Unfortunately, right now, it's a little bit basic -- Honey Nut Cheerios have made their rerounds to me. But traditionally, go back a month, it was always Special K.

Hill: Really? 

Flippen: Oh, yeah! The flakes are so crunchy.

Hill: Yeah, and they've done a lot with flavors. That's one of those things where they've expanded to different flavors.

Flippen: I will admit, I did buy the pumpkin spice Special K.

Hill: How is it?

Flippen: Eh... I'm still eating the Honey Nut Cheerios. 

Hill: Emily Flippen, thanks for being here!

Flippen: Thanks for having me!

Hill: As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. That's going to do it for this edition of MarketFoolery! The show is mixed by Dan Boyd. I'm Chris Hill. Thanks for listening! We'll see you tomorrow!