Another quarter and another lowering of full-year 2020 earnings guidance from FedEx (FDX 1.53%). It's becoming a familiar, and disappointing, refrain from the company. That said, it usually pays off to keep a clear head when making investment decisions, and it's fair to say that FedEx has been hit with a mix of unusual external headwinds this year. Moreover, the stock price decline -- down 6% in the last year and underperforming UPS (UPS 2.81%) by over 35% points -- will inevitably attract investors to an iconic American company. Let's take a closer look at what's going on and what you need to know about investing in FedEx.
Image source: Getty Images.
FedEx lowers guidance, again
I'll start with the bad news. Having started its fiscal 2020 with guidance that implied $14.60 to $14.90 in diluted EPS (before retirement plan adjustments and TNT Express integration expenses), management lowered it to $11-$13 on the first-quarter earnings call in September. Fast-forward to the second-quarter earnings in December, and the guidance was lowered again to $10.25-$11.50.
Global trade slowdown
FedEx has certainly been hit by factors beyond its control in 2019. Most prominently, a combination of the trade war and slowing global economic growth has led to weakening of international trade -- something you can see in the chart of cargo growth data from the International Air Transport Association (IATA).
The slowdown hurts FedEx in two ways. First, it reduces revenue -- CEO Fred Smith noted "reductions in international air freight and tepid-at-best B2B domestic parcel and freight shipping" on the recent earnings call. Second, FedEx's B2B deliveries tend to be higher margin than B2C deliveries, and revenue per package in FedEx Express international export packages is at around $50, compared to around $19 for U.S. packages.
Smith said that as a consequence "we are taking down the intercontinental capacity right after Christmas, as our hopes for a restoration in trade growth, expressed last June, has simply not materialized due to the trade dispute."
Data source: IATA presentations. Chart by author.
Cost increases
FedEx also suffered an earnings headwind from "higher-than-expected expenses" in the quarter, most notably in FedEx Ground. In fact, a $421 million increase in expenses more than ate into the $173 million increase in revenue in the segment.
In the end a combination of a decline in Express revenue and rising costs in Ground led to a significant drop in reported operating income.
| FedEx Segment (Q2 2020) |
Revenue |
Change (Year Over Year) |
Operating Income |
Change (Year Over Year) |
|---|---|---|---|---|
|
Express |
$9.08 billion |
(5%) |
$236 million |
(63%) |
|
Ground |
$5.31 billion |
3% |
$342 million |
(42%) |
|
Freight |
$1.84 billion |
(4%) |
$141 million |
(5%) |
|
Total |
$17.32 billion |
(3%) |
$554 million |
(53%) |
Data source: FedEx presentations.
It all adds up to another disappointing quarter for the company, and investors immediately put the stock in the doghouse.
The case for a comeback
The glass-half-full approach uses two justifications:
- International trade conditions are beyond FedEx's control, and the pressure on Express revenue growth and margin expansion will abate given easier comparisons with this year and/or an easing in trade tensions alongside the capacity reductions.
- Ground costs have gone up in order to service a stronger-than-expected peak season, the shift to six- and seven-day delivery for the majority of the U.S., and expansion of the network to service e-commerce growth.
In other words, even though the numbers don't look good in the near-term, FedEx could easily turn things around in the future, aided by an easing in trade tensions. Meanwhile, the increase in Ground costs is for a good reason and will improve the quality and capability of its service to customers.
Indeed, Smith is expecting an improvement in 2020: "In the fourth fiscal quarter, we forecast FedEx Ground margins will again be in the teens." For reference, Ground margin was just 6.4% in the recent quarter, compared to 11.5% in the same quarter last year.
Meanwhile, FedEx now trades on a clear valuation discount to UPS.
FDX EV to EBITDA (Forward) data by YCharts
Finally, just as UPS is starting to demonstrate progress in its intent to expand margin while taking on burgeoning e-commerce demand, FedEx can follow in due course.
So is FedEx a buy for 2020?
Putting it all together, there is a case for buying FedEx, but is there a case for buying FedEx over, say, UPS? The difference between the two is that UPS is starting to demonstrate it can cut costs and expand margins with e-commerce delivery expansion, but as yet, FedEx's reported performance remains patchy at best. In addition, the guidance cuts have been coming in exactly the same economy that UPS has been dealing with.
All told, FedEx is worth monitoring, but risk-averse investors will want to see some hard evidence of improvement and a couple of better quarters of execution before buying in. The stock is very interesting, but after continued cuts in guidance, investors may want to see a couple of quarters of stabilization before buying in.
