FedEx's (NYSE:FDX) third-quarter earnings are in, and while the numbers may have squarely beaten analysts' estimates, the shipping company has done something investors don't often get to see: suspend, not just slash, its outlook for 2020 as the COVID-19 coronavirus outbreak spreads around the globe.
In a recent conference, rival United Parcel Service (NYSE:UPS) had already warned of shipment disruptions and a slowdown in business in the ongoing quarter. Commercial economic activity is the lifeblood of shipping and logistics stocks, and there's no knowing how hard the coronavirus pandemic could hit global trade -- and, more importantly, for how long.
It's a double-whammy for FedEx, as it already entered 2020 with more challenges than it could count. There is a silver lining, though: A newly launched delivery program bumped up volumes in Q3 and could help FedEx make big strides in e-commerce if it can execute the program as planned.
A quick look at FedEx's Q3 numbers
FedEx's revenue improved 3% year over year to $17.5 billion on higher residential delivery volumes at FedEx Ground, but a 6% jump in operating expenses sent FedEx's operating margin tumbling to 2.4% from 5.4% in the year-ago quarter. Net income more than halved to $351 million.
Management blamed a multitude of factors, including but not limited to:
- Macroeconomic weakness, exacerbated by the coronavirus pandemic.
- Higher FedEx Ground costs.
- Loss of business from key customer Amazon.com (NASDAQ:AMZN).
- Higher self-insurance accruals.
- A competitive pricing environment.
Pay particular attention to the second and third points, as both relate to FedEx Ground, the company's largest segment.
In December last year, Amazon barred third-party sellers from using FedEx Ground for its Prime shipments, citing performance concerns. Loss of business from such an important customer during peak shopping season was bound to show up on FedEx's numbers. UPS, meanwhile, continued to serve Amazon through the holiday season.
On the positive side, though, higher costs at FedEx Ground may not be all bad news, as part of the costs relate to an expansion program that's actually one of the brighter spots for FedEx right now.
In other good news, FedEx's pricing power was on display in Q3, as both FedEx Express and FedEx Ground increased average shipping rates by 4.9% and FedEx Freight by 5.9% in January.
FedEx wants to take on Amazon and UPS with its new program
Despite the Amazon blow, FedEx Ground reported 11% year-over-year growth in Q3 revenue, thanks to one big initiative: seven-day residential delivery, starting back in January.
By adding an extra day of delivery services, FedEx is trying to hit several targets:
- Better utilization of its existing fleet.
- Attracting more e-commerce customers with Sunday deliveries.
- Speedier and higher volume deliveries.
- Making headway into last-mile delivery.
"Last mile" is the final stage of delivery of a good from a local distribution center to the customer's home and is the hottest growth spot in e-commerce right now, with XPO Logistics (NYSE:XPO) leading the space in North America. Nearly 8% of XPO's transportation segment revenue (it also runs a logistics segment) came from last-mile delivery in 2019.
FedEx's seven-day program renews its focus on last-mile delivery of heavy goods such as home appliances and furniture, demand for which is steadily gaining ground. Until mid-last year, management revealed that such large packages made up roughly 10% of FedEx Ground's revenues.
Equally important, FedEx is consolidating its SmartPost packages, or the smaller packages delivered through the U.S. Postal Service, into its FedEx Ground service. By the end of 2020, FedEx expects to serve all home deliveries through its own ground service.
So while delivery expansion drove FedEx's costs higher in the third quarter, it also boosted average daily volume by 10%. During FedEx's third-quarter earnings conference call, management revealed that its seven-day program has expanded FedEx's reach to 188 million homes, accelerated delivery of 16% of its home delivery volumes by at least one day, and helped deliver 72% of total volumes within two days. FedEx Ground is also faster to more locations than UPS Ground, which undeniably makes its seven-day home delivery one of FedEx's best moves to catch up with Amazon's swift delivery and XPO's last-mile lead.
How badly could coronavirus hit FedEx?
FedEx Ground volumes could continue to grow, but I can't say the same for FedEx's international operations, at least as long as coronavirus fears linger. Europe and Asia-Pacific could be the toughest markets to navigate, especially when FedEx is already struggling to integrate TNT Express in Europe. The entire integration program could cost FedEx nearly $1.7 billion through 2021.
In December, management projected margin percentages in the teens for FedEx Ground in Q4. That looks tough now, given the higher costs and the coronavirus uncertainty. The impact of the lockdowns on global travel and trade on shipping could be substantial, which is why FedEx has withdrawn its previous guidance for 2020, which called for adjusted earnings of $10.25 to $11.50 per share.
An easing trade war combined with FedEx Ground's growth moves could've been the turnaround story that investors have been waiting for -- specifically, growing revenue flowing to its bottom line. Sadly, coronavirus won't let FedEx have it so soon, so easily.