Why United Airlines Got a Boost

In this episode of MarketFoolery, host Chris Hill and Motley Fool Senior Analyst Abi Malin go through the latest headlines from the markets. There are surprise results on the delivery front, and investors have something to cheer about as a top U.S. winery posts better-than-expected results. They also talk about the airline industry and much more.

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This video was recorded on July 1, 2020.

Chris Hill: It's Wednesday, July 1st. Welcome to MarketFoolery. I'm Chris Hill. Joining me today, the one and only Abi Malin. Good to see you.

Abi Malin: Thanks for having me.

Hill: We've got some stuff to talk about. We've got airlines, we've got alcohol, but we're going to start with FedEx (FDX -0.43%).

And for the first time in a while, we've got some good news out of FedEx. Fourth quarter profits and revenue came in higher than expected, stock up somewhere in the neighborhood of 12%, 15% so far today. And maybe this shouldn't be a surprise given the rise in boxes of stuff being delivered to everyone's home.

Malin: Yeah, I mean, I think this is a fun one to follow today just given this is the first time we've seen positive news from FedEx in a really long time. I will, sort of, temper that news with the fact that it wasn't necessarily a knock it out of the park quarter for them, it was more that expectations were very, very low and they exceeded that.

So, like you said, they did have peak level e-commerce volumes in the U.S., which I think is a pretty interesting metric to look at, but generally, they spoke a lot about how commercial volumes were down significantly due to business closures across the globe.

Hill: Well, and one of the things that FedEx continues to deal with, and this is worth remembering for all businesses including the one we're going to talk about in a few minutes, just the idea that acquisitions are hard, it's exciting usually when a business acquires another business, but that doesn't mean it's not challenging to incorporate an entire new business into your business. And in the case of FedEx, TNT Express based in Europe, you know, that integration, I think it's fair to say, that's not going [laughs] as smoothly or as inexpensively as FedEx and its shareholders were probably hoping for.

Malin: Yeah, I would agree with that. I mean, management commented on the call that they estimate it to be about at $1.7 billion expense to sort of fully integrate that by 2022. They're recognizing about $175 million of that in the current fiscal year; so, they're really pushing off those expenses. Which again, I think, you know, when you're looking at this call, if you compare their GAAP reported to non-GAAP or adjusted numbers, you're going to see a pretty big difference and a lot of it has to do with not only just integration cost with TNT Express but also goodwill impairment as well as retirement plan contributions.

Hill: Do you think, given the surprise results of this quarter, do you think this raises expectations, fairly or unfairly, for what they're going to report in three months?

Malin: A good question. I'm not sure about whether this, sort of -- I mean, it has to, right, it has to raise expectations for three months. But I think, generally speaking, I've said it before, I'll say it again, logistics is a very hard business. And so, FedEx's is competing in a space that is challenging at best and increasingly challenging given the time that we are currently operating in with this global pandemic. And so, they actually mentioned that the $125 million increase in operating cost was directly related to personal protective equipment and medical and safety supplies as well as additional security and cleaning services.

So, I don't expect operating expenses to, sort of, ramping back to what they were before this. And so, for the full fiscal year, the operating margin actually declined from 6.4% last year to 3.5% in this year. Again, not fully due to COVID, but I just think they're working with a lot of headwinds that I think are going to be very difficult to moderate in the future.

Hill: Well, and one more complicating factor that FedEx has to deal with when it comes to getting packages from point A to point B is all of the investments that Walmart and Target, in particular, have made over the last three months to enable people to pick stuff up, to enable that curbside delivery so that it's as seamless and as smooth as possible. You know, that's great for Target and Walmart, and they're doing the right thing for themselves and for their customers. But everything that gets picked up is one more thing that's not going to be shipped.

Malin: Right. I mean, it's an interesting, sort of, quandary that they're in. So, their two main strategic focuses right now are to manage network capacity to align with volumes and operating conditions, as well as remaining focused on that last-mile optimization. And so, that is what we're talking about when you talk about residential deliveries. And I think it's important to note, those residential deliveries, while they are driving the increase in volumes, particularly in this last quarter, they do require incremental cost-to-serve, right? So, that last mile is actually the most expensive to do just given the bulk logistics of it. So, it'll be an interesting dynamic to see how this plays out going forward, specifically in the margins for them.

Hill: Let's stick with at least part of FedEx's realm, and I'm referring to the airlines, because United Airlines (UAL 1.69%) came out with some news today. They're planning to add 25,000 flights in August. This is another one [laughs] that's going to be interesting to watch how it plays out, because this also comes at a time where United is boosting that capacity for, you know, 48 weeks from now, but they're also quick to point out that they've seen a flattening of demand over the past week as COVID-19 cases rise here in the U.S. But for the moment, anyway, [laughs] if we're judging these two announcements by the movement of the stock, the boosting capacity in August appears to be winning out, because shares of United Airlines are up about 3% this morning.

Malin: Yeah. This is another industry, man, I am not envious of the role [laughs] that all of these executives play at United here. So, their domestic schedule is now at about 48% of the prior year's levels; 40% if you include international flights. And I think this ramping up challenge or ramping back up to what was previously offered, it's going to be interesting to watch, particularly across the competitive landscape.

Hill: Well, it's also one of those things where we've been looking at this for the past few months and getting a lot of questions from our members about the airlines, about the cruise lines, but we're not going to talk about the cruise lines. But, you know, looking at the airlines and saying, look, this is a vital business, of course, it has to survive. But I think there's a desire on the part of some investors to look at all of the airlines as a group and just think, OK, well, they're all going to be -- like, if this is happening with one then it's going to happen to all of them, and that's just not the case.

Malin: Yeah, that's a good point. I mean, generally speaking, airlines are -- it's a challenging business because they are asset heavy, they're capital intensive businesses, they have high fixed costs. And so, I think it's sort of a two-fold challenge, right? So, you could ramp up too quickly, which would mean that you're running too many planes at a loss. So, obviously demand is, to some degree, a function of pricing, but you're also seeing travel restrictions and travel bans come into play. So, that is something to consider, right? But then on the flipside, if you ramp up too slowly, you could lose your market share to competitors.

And there is a cost with planes not flying. So, they have to be stored somewhere. For United, they store them at hub airports mainly that include more than 40 planes at Houston's IAH. So, it's just a logistically interesting and hard challenge to get through.

Hill: Constellation Brands (STZ -0.15%) out with first quarter profits that were higher than expected. Constellation, put them in the category of those companies where the underlying brands are better known than the name of the company itself. This is a beer, wine and spirits company. They've got Corona Beer, Modelo, Mondavi wine, a number of spirit brands. They also added to the wine portfolio by buying a direct-to-consumer business called Empathy Wines.

Look, the first quarter profits, those were nice, I'm wondering if the fact that shares of Constellation are up 8% today maybe has more to do with the fact that they made this acquisition?

Malin: Yeah, I think it is a lot to do with this acquisition. So, like you mentioned, they're acquiring Empathy Wines which is a direct-to-consumer wine business. And it's started by a well-known entrepreneur, wine expert, and media personality Gary Vaynerchuk. So, their sort of offering is that they do sustainably raised wine delivered direct to consumers for about $20 per bottle. And so, while the terms of this deal weren't announced, I think the strategic movement for Constellation Brands is an interesting one.

Hill: I'm always fascinated whenever the amount of money is not disclosed. It's, you know, in part because -- and I don't own shares of Constellation Brands, but I just sort of look it at as, like, hey, a public company. This is not Apple, this is not Apple because we've seen huge tech companies make acquisitions, they don't disclose the amount and we know it's because, well, look, on a material basis it's pocket change to them. Constellation Brands is not [laughs] that size, so I am curious what they paid. My hunch is, they paid a lot less for Empathy Wines then the investment they made in Canopy Growth.

And this is really interesting to see how Bill Newlands, who is the CEO of Constellation Brands; and he's been CEO for just a little over a year. He appears [laughs] to be quietly, methodically dismantling the [laughs] moves that his predecessors made. Whether it's writing down the Canopy Growth acquisition, whether it's -- you know, that was the thing at the time of the Canopy Growth acquisition, where I just thought, wait a minute, why would you invest that amount of money when you appear to do a pretty good job of getting these alcohol brands into your distribution network, why not go back to that playbook, it looks like that's what Bill Newlands is doing with this acquisition.

Malin: Yeah. I mean, they've recently made a strategic decision to focus on selling, sort of, those higher tier wines. So, at the end of 2019, they sold off their lower priced wine portfolio to E&J Gallo for about $1.1 billion. It's certainly a strategic decision, I would say. And I think their VP or President of Wine and Spirits made some interesting comments about the adoption rate of purchasing alcohol direct-to-consumer. And so, he said, pre-COVID, only about a third of people really needed to buy alcohol online, but now that number is probably 80% to 90%.

But I think it's fair to assume that this acquisition isn't because of what's going on right now, this is certainly a long-term play for them. And so, he talked about the acceleration in that direct-to-consumer channel and that they estimate that direct-to-consumer is growing at 2X the rate of the general market. So, I think part of this acquisition is just the inside knowledge, datapoints, sort of, the learning that they can get from this direct-to-consumer channel and maybe exploring that more to roll across other brands.

Hill: Two quick things before we wrap up. First, you go back to March, and one of the things that we were all saying was, as companies, you know, were tripping over themselves to say, we're not giving any financial guidance. Now, we're getting [laughs] into, sort of, the summer round of earnings. And, you know, Constellation Brands and FedEx both coming out and basically sticking with that course. You know, each in their own way saying, look, given all of the continued uncertainty in our business, whether it's delivery of packages or selling alcohol, both of them coming out and just saying, yeah, no, we're not [laughs] giving you guidance.

Malin: Right. The choice to not give guidance is one that I understand right now, certainly across a variety of industries. I don't think Constellation Brands is necessarily the most unclear business that we have going forward, but I understand the choice not to.

Hill: Last but not least, Happy Bobby Bonilla Day! I don't know; how big a baseball fan would you say that you are?

Malin: Well ...

Hill: [laughs] OK. And also, you're much younger than me, so if you're not a big baseball fan then chances are you weren't watching Bobby Bonilla when we played in the 1990s. But the reason today is Happy Bobby Bonilla Day is because he signed, arguably, the greatest contract in all of major professional sports. He signed it with the New York Mets in the late 1990s, and it does have an investing angle to it, because basically the contract pays Bobby Bonilla, who has been retired from baseball for a long time, it pays him $1.2 million annually on July 1st. And this will continue until the year 2035 when he will be in his 70s.

And the reason the New York Mets gave him this contract is because they were so confident with the money they were making off of their investments they were investing with this guy, who was delivering consistent returns year-after-year, a man by the name of Bernie Madoff. And so, Bernie Madoff and his Ponzi scheme have a direct tie to Bobby Bonilla signing the greatest contract in professional sports.

So, I don't know how you are celebrating Bobby Bonilla Day, I know he's celebrating it by, you know, getting that $1.2 million check. Isn't that amazing?

Malin: Yeah, what an interesting collision of sports and finance and history. [laughs]

Hill: I knew about the contract when it was signed. And this was well before I had heard about Bernie Madoff, and the fact that there's the Madoff angle, just makes the story all the more delicious.

Anyway, Abi Malin, always great talking to you. Thanks for being here.

Malin: Thanks for having me.

Hill: As always, people on the program may have interests 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 Rick Engdahl. I'm Chris Hill. Thanks for listening. We'll see you tomorrow.