Bellwether FedEx (FDX +0.77%) falls after a rough start to the fiscal year and lowered guidance for the rest of it. Adobe (ADBE +0.83%) posts record revenue in the third quarter but shares of the software giant fall anyway. Motley Fool Chief Investment Officer Andy Cross analyzes those stories and a surprisingly profitable quarter from Stitch Fix (SFIX 3.93%).
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This video was recorded on September 22, 2021.
Chris Hill: It's Wednesday, September 22. Welcome to MarketFoolery, I'm Chris Hill. With me today is the Chief Investment Officer, Andy Cross. Good to see you.
Andy Cross: Chris, good to see you. Thanks for having me back.
Hill: We've got earnings and we're going to start with the bellwether. Shares of FedEx are down to eight percent, and that is actually not all that surprising when you consider the fact that first-quarter profits were lower-than-expected and FedEx cut their earnings guidance for the full fiscal year. I don't want to paint this as being horrible, I was about to say, is this as bad as it looks? But this looks like a very straightforward struggle in the near-term for FedEx. Am I wrong?
Cross: The stock's been selling off for the past few months, I think it's down to 15 percent or so when you look at the past few months, Chris. When you look at what they have discussed on this call, it's fascinating from the perspective of this is showing a lot of what we have heard about when it comes to things like labor. It's specifically about labor shortages and the struggle that so many US companies are having. Especially a company like FedEx that hires hundreds of thousands of people and relies on systems and processes and people. Their sales were actually up pretty nicely for the quarter Chris, up 14 percent, their freight business was the best performer of 23 percent. Total US shipments across their network was only up 1.5 percent, so that's compared to more than 30 percent for all of the fiscal year 2021. Again, coming off that really robust during the pandemic, we saw shipments and all the e-commerce business just start to shift online and shopping started to shift online. But for a while it was really tense and obviously the depths of the pandemics, so the growth in shipments this quarter wasn't nearly as exciting. It's only up 1.5 percent, but it was really on the cost side.
Chris, the operating income was down 12 percent, operating margin fell to 6.4 percent versus 8.2 percent a year ago, and that really hurt the earnings-per-share that fell more than 10 percent. Almost so much that Chris was driven by labor shortage and the cost. They estimate that during the quarter, more than 450 million of additional costs were leaped or added to the cost structure because of labor shortages that really hurt. Not just the fact that they had to pay more for those workers, which they had to, but also what it did to the efficiencies of the network. Just you saw shortages on having people in the network and what that meant for them being able to ship packages from point A to point Z, and that really hurt the bottom line when you look at FedEx. It was a little lower on the shipping volumes and then the cost pressure jumped in and that's why you see the stock selling off today.
Hill: There are a lot of companies that sandbag their guidance, I don't think FedEx is one of them. I think historically they've been a little conservative with their guidance, but I don't put them in the category of sandbagging. But I think that what you just mentioned is part of why we're seeing this sell-off today because another thing they mentioned was, and this was to be expected this time of year, they talked about seasonal hiring. FedEx is looking to hire as many as 90,000 people, and I think for some investors they listened to everything FedEx said about the struggles they're having in hiring. Then they said, "By the way, we're looking to hire 90,000 people in the next few weeks." It's like, "Okay. Well, forgive me if I'm skeptical about how that's going to go." Because [laughs] it hasn't been going well so far.
Cross: It's been very expensive. They said the competition for talent, particularly for the frontline workers have driven wage rates higher and pay premiums higher, and they're taking what they call these bold actions Chris, across the entire enterprise to hire and invest in those frontline team workers. These actions include targeted paid premium for weekend shifts, increased tuition reimbursement, sponsorship of a National Hiring Day on September 23. If you're looking for some work and interested in FedEx, September 23 could be your day to help hire those 90,000 additional positions ahead of the peak. Look at the long-term Chris on this. Here's the story for FedEx, they still expect shipment volumes per year to increase about 10 percent over the next five years. You have a business that has a market cap of 67 billion. They've a lot of debt, they have 36 billion on the balance sheet, seven billion of cash, so you have a company that has an enterprise value of nearly a 100 billion there. Their price to sales is only 1.1, their price to earnings is about 13 times. With their five-year EPS growth rate of about 10 percent, with a dividend yield of 1.2 percent in the stock that's fallen 15, 20 percent over the last three months. There's not really a lot of surprises in this, I don't think we've seen the shortage and this is really acutely hitting FedEx, it also probably will hit UPS. I think it probably will hit a company like Amazon that has got a massive logistics network they are building out.
We do see these cost pressures building up, FedEx has just announced that they're going to increase some of their shipping costs across the FedEx Express, FedEx Ground, FedEx Home Delivery. The rates will increase by almost six percent, and FedEx Freight will increase between six and eight percent. They're going to try to offset some of these costs with some higher shipping rates to help grow and offset some of these costs that they're feeling. Overall, I think there's not too many surprises, I think with FedEx, and it could just be one of those stocks you just wait and see, and I'm not jumping into the stock now. But if their earnings picture and the price continues to fall, it might be a little bit more attractive especially if you're interested in those companies that have a dividend yield of above one percent.
Hill: Adobe's third-quarter profits and revenue were both solidly higher than Wall Street was expecting, but shares of the software giant down three percent today. Their revenue was nearly $4 billion in the quarter, that's a record.
Cross: Oh gosh Chris, up 22 percent for the year. The earnings picture is [..].] very healthy in the digital media, which is their largest business, was up 23 percent year-over-year. They exited the quarter with almost 12 billion in annual recurring revenue. Their subscription business which is really driving the bulk of revenues and their cash flow was up 24 percent at 3.66 billion, while the products were up a little bit less and the services were actually down, so really the subscription business looking at all of the products that Adobe is offering. When you look at the Creative Cloud, their Document Cloud business which is designed around like signages and helping their clients being able to continue to offer DocuSign like businesses or solutions. That was really impressive, up 31 percent year-over-year to almost $500 million. Their signage traction continues to grow with people using the systems, so we need to be able to sign documents, you can do it right in the Document Cloud if you are a subscriber, Document Cloud as an Adobe client.
Overall, you just look at this business, it's a $300 million business. They have plenty of cash, not very much debt, gross margin is almost 90 percent Chris, operating margin is above 35 percent. You have a stock that makes a lot of money, they buy back a lot of stock using their free cash flow that they generate to be able to lower the share count, which drives a lot of the earnings-per-share growth. Overall, 20 percent topline growth, more than 20 percent probably on the earnings side, long term. It continues to be very attractive and very well-positioned to serve clients that continue to move more and more to this creative space like architects, designers, businesses, anyone that utilizes all of those solutions that Adobe offers like Photoshop. They just continues to be a winner in that space and it's a wonderful business, very solid. The price is probably a little bit stretched ahead of it. I'm an owner, very happy owner to be and if it continues to fall a little bit, I will be a buyer.
Hill: I think that is probably why we're seeing or at least part of why we're seeing the drop-off today is that unlike FedEx, Adobe has just been on such a run for so long. It's not at an all-time high, but it's pretty close to it. You look at the valuation and you see how Adobe has essentially entered the territory that some companies get to where you're going to need near-perfect or perfect results for the stock to move up.
Cross: Yeah, I think that's right Chris especially at this size. They make healthy acquisitions, they bought a company called Marketo to build out their commerce business, which again continues to compete against the likes of Shopify and those kinds of organizations that are continuing to build out that very sticky ecosystem across the creative landscape. When it comes to things like analytics and marketing for your business and advertising, that's the area where Adobe is moving more into, and they make these little acquisitions to be able to continue to solidify all the great innovation that comes inside their own organization. It's just a healthy balance of a really nice software company that certainly has high expectations, but over time they've really been able to deliver against those. Again, just looking at the financial picture of what Adobe is build, it's pretty impressive.
Hill: The stock of the day is Stitch Fix. Shares up 15 percent after the online styling service reported a surprise profit in the fourth quarter. I feel like I've seen this movie before where it seems like Stitch Fix does this a couple of times a year where they beat expectations. This is a stock that has a decent short interest.
Cross: Yeah.
Hill: I'm sure that's part of what we're seeing today with Depop.
Cross: Yeah. It was actually a really nice quarter, sales were up 29 percent.
Cross: But again, coming off a pretty low base from a year-ago. If you go back two years ago before the pandemic sales were up about 15 percent. That's a deceleration of the quarter before. But again, coming off a very low base. Number of active clients was up 18 percent to 4.17 million. I'd like to see that number continue to be in the healthy teens, stagnated in around there. That's a little bit of a deceleration from the previous quarter of around 20 percent, but still pretty nice. Net revenue per client up four percent to $505. Chris, that's the first time it's been over 500. That's been pretty nice and an improvement of what happened last quarter. As you mentioned, I was really surprised at the profitability picture that I think it has people a little bit excited.
Their gross margin was at 46.5 percent versus 46 percent. That was driven by higher product margins. They did a really nice job managing the costs. They did see higher wages in shipping. Again, getting back to FedEx, like we've seen, continued costs into the ecosystems and into the networks. But they said that was offset by variable and fixed productivity gains. That shows up really in the sales and general administration costs as a percentage of revenue was at 37.2 percent this quarter versus 44.4 percent a quarter ago. You really see improvements across the scale of the organization that drove that profitability picture, as you mentioned, EPS of 19 percent versus a massive loss a year-ago and far ahead of analysts estimates of minus 13 percent. Overall, success in the women's business, the kids, the freestyle, which is what they now call the direct buy business, which allows you to directly buy through Stitch Fix's website versus having to get it done, having worked with a stylist. International were some of the big areas of winning this corner and our churn remains really near low. Overall, you wrap that all in and you can see why people are excited or investors are excited to perhaps buy the stock today. As you mentioned, it does have that high short interest so you probably have people trying to cover that short.
Hill: It seems like Stitch Fix, as I said, they do this a couple of times a year and the challenge for them, among others, is that they haven't proven to this point that they can do this on a consistent basis. The sustained profitability and this is, I wouldn't say it's a mature company, but it's not as young as it used to be. I feel like it's reasonable to expect, at least in 2022, if Stitch Fix is going to really establish itself, they got to start doing this on a regular basis.
Cross: Well, it may have new leadership being Katrina Lake stepped away from the CEO role and they have the new CEO in. I think that's going to bring a little bit of life to Stitch Fix. She talked about how freestyle again, that direct buy part of the business was really up, more than doubled during the fiscal year of 2021. She talked about how over the last 18 months they've just seen the shift where their footwear and apparel business overall, that market was about a quarter, 25 percent of that with join online and now that's close to the 40 percent. The market has definitely moved online, no surprise, I think we all know that.
But they are seeing these little pockets of wins, the keep rates or those who keep things that they order as opposed to sending them back. Those are near all-time highs. Churn near all-time lows. The women's plus business grew 51 percent in the fiscal year. Tops and bottoms overall for their business is about 75 percent of their sales, but it's really only about 30 percent of the overall categories that leads to opportunities and things like Footwear and dresses, outerwear and sleepwear. She identified these areas both from opportunity to add more sales tie better into their clients, offer more of those solutions that their clients are looking for, working with stylists, making improvements to their algorithm and also attacking different parts of the market and managing their costs. All that being said, you still have a business that doesn't make a lot of money. It has decent growth rates.
I'm an owner, but I'm not really a buyer right now. I'm just holding and sitting the stock. The market cap of the business is almost four billion. They have 230 million in cash on the balance sheet, 140 million in debt. The price to sales ratio is less than two. But they still continue to have a lot to prove in the market. It's a very competitive space obviously. They have these little wins but they just need to be able to consistently do this. Maybe the new leadership team can take him there.
Hill: I think 2022 is going to be a very interesting year for this business because if they continue to improve in a way, even though that increases the market cap, theoretically right now it's just under $4 billion. If they continue to improve, my hunch is that only increases the interest from larger companies who are thinking about acquiring Stitch Fix.
Cross: Yeah, Perhaps. It's interesting Katrina Lake has been selling down her stage. She is the Founder over the last few years, so it just struck me. She still owns a lot of the cards, almost 10 million shares, but that was close to 15 million shares back in 2017. I don't know if anybody would necessarily or has it on the horizon, but they continue to invest in their algorithm, they continue to invest in their client relationships and offer those different solutions for their clients, predominantly women, but their expanding continued. They said, like I've mentioned, had some wins in kids and international is a big opportunity. Very fragmented market.
They think they can play into that. Maybe that is attractive because there's so much of that style plus algorithmic combination that they continue to own and to work on. They do have some little specialty and they are expecting sales next year to be up about 15 percent or a little bit higher. That's fairly attractive and it continues a nice momentum that we saw over again. If you look over the two-year period, not just over the past year, which we've seen that elevated growth off the lows of the pandemic, but that's a nice growth continuing over the last couple of years. If they can do that and their profitability stays at this level, you're going to see some nice earnings and cash flow growth, which start to put them in a little bit of a different perspective and different high as a growth company that also can drive profits and that might be very attractive to other investors.
Again, I own the stock, but I'm just in the wait-and-see. Like you said, I want more of that consistency, I want to see how with this leadership team can bring today and this quarter was pretty nice indication, but that needs to be sustained and needs to last.
Hill: Andy Cross, Great talking to you. Thanks.
Cross: Thanks Chris. I appreciate it buddy.
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. Some of buyers sell stocks based solely on what you see here. That's going to do it for this edition of MarketFoolery. The show's mixed by Dan Boyd. I'm Chris Hill. Thanks for listening. We'll see you tomorrow.
