Package delivery company FedEx (NYSE:FDX) is scheduled to report earnings for the first quarter of its 2016 fiscal year on Wednesday. In the three months since FedEx's last earnings report, the stock has plummeted nearly 20%, from a high of around $185 to less than $150.
To some extent, that may be a reaction to FedEx CFO Alan Graf telling investors in June that analysts' Q1 earnings estimates were too high. In the past 90 days, the average Q1 EPS estimate has come down from $2.66 to $2.45.
However, an even bigger potential worry is that economic weakness in China and other key markets will cause a slump in revenue. FedEx's earnings report and management commentary should provide some important insight into this critical issue.
Economic uncertainty has been a constant
The economic uncertainty that is currently weighing on FedEx stock has been a recurring theme in recent years. It's been nearly a decade since FedEx has benefited from a truly healthy global economy.
Even as global GDP has bounced back from the Great Recession, some countries have continued to struggle. Moreover, businesses have remained cautious, attempting to rein in spending. As a result, demand for FedEx's expensive International Priority shipments has never recovered to pre-recession levels.
To address this issue, FedEx introduced a broad restructuring program in its Express business segment in 2012. The goal was to slash costs while still offering the service that customers expect.
At a high level, the restructuring program has been a big success, driving strong growth in FedEx Express segment profit. But there have been bumps along the way. FedEx has had to cut flights to Asia more than once due to weak demand. It has also gone through multiple rounds of retiring aircraft ahead of schedule to cut capacity and boost efficiency.
The key takeaway is that even if slowdowns in China and elsewhere have started to impact FedEx, I expect the company to have a clear plan to address that weakness. The current patches of weakness aren't fundamentally worse than what FedEx has overcome in the past few years.
Room for growth at home
Meanwhile, the U.S. economy continues to chug along. Even if the international market remains spotty for FedEx, the company has plenty of room for profit growth at home, particularly in the FedEx Ground business.
FedEx has been investing heavily in the Ground business recently, spending more than $2 billion on capex over the past two years. The company wouldn't be spending that much money to expand capacity unless it saw big growth opportunities on the horizon.
Given how fast e-commerce is growing, it's easy to understand management's optimism. As FedEx starts to leverage its fixed investments in the Ground business and take advantage of new software tools to optimize package routing, it should see accelerating profit growth at FedEx Ground. With the busy holiday season coming up, management is likely to highlight the strength of this business on the earnings call.
Room for error
In its last earnings report, FedEx presented preliminary earnings guidance for the current fiscal year, calling for EPS to rise 18%-24% to a range of $10.60-$11.10. Based on the midpoint of that estimate, FedEx stock currently trades for less than 14 times forward earnings.
That represents a discount to the market, despite the success of FedEx's ongoing restructuring program and the long-term growth potential of the FedEx Ground business. Clearly, fear about weakness in various major economies has severely dampened investor enthusiasm for the stock.
However, there's a good-sized margin of safety built into FedEx's valuation at this point. And FedEx's upcoming earnings report will give the management team an opportunity to reassure investors about the company's positive trajectory.