FedEx Corp. (NYSE:FDX) wants folks to look past the valley of fiscal 2020.
The 2020 fiscal year, which began June 1, will be one of “transition,” FedEx said, using the corporate codeword for a year to forget. Instead, FedEx urged the analyst community gathered around the squawk box June 25 to dissect the company’s fiscal 2019 fourth quarter and full-year results to fix their gaze on fiscal 2021.
By then, according to executives, FedEx will have become the lowest-cost provider of residential ground deliveries in the U.S., an achievement, if it occurs, that will absorb a chunk of its $5.9 billion CapEx budget this fiscal year. Its seven-day-a-week U.S. delivery service, which the company said businesses are already lining up to try, will have kicked into high gear. FedEx will have added density and, by extension, operating efficiencies by shifting parcels currently tendered to the U.S. Postal Service into its ground network. Its infrastructure will be able to properly handle more large-format e-commerce shipments. The loss of $150 million to $200 million in annual U.S. air business from Amazon.com. Inc. (NASDAQ:AMZN) will have been offset by higher-yielding volume from a broader base of air shippers, executives said.
FedEx’s difficult integration of TNT Express will be at or near completion, I.T. systems will be optimized, and a key reason for the deal, to inject express packages into TNT Express’ pan-European ground network–will be realized, according to executives. Hopefully for FedEx, the U.S. and China will have resolved, or at least reached a compromise, over their trade dispute that has cast a cloud over the flow of global goods the company relies on so heavily. Should animal spirits revive and traffic improve, FedEx Express will disproportionately benefit because incremental volume hits its bottom line with more velocity than at its other two units, FedEx Ground and less-than-truckload (LTL) operator FedEx Freight, FedEx Chairman and CEO Frederick W. Smith said.
Yet FedEx still needs to get there from here, and here is not where it wants to be. The domestic business, on balance, is doing fine, though there are concerns over the company’s ability to fill planes with enough e-commerce business in the wake of Amazon’s departure– especially since most of the stuff is too cheap to justify shipping by air–as well as a reported trade-down in two-day air deliveries to cheaper ground service, a report that executives have strongly disputed. The big problem remains outside the U.S., where margins continue to be squeezed by a lack of premium-priced priority traffic and too much lower-yielding palletized freight from TNT customers. For example, “yields are not good coming out of Asia,” said CFO Alan B. Graf on the analyst call.
Then there is the global macro outlook, with the U.S.-China trade dispute smack in the middle. FedEx executives acknowledged that clarity over its international business won’t come until it sees daylight on the trade talk front. Beyond that, Asian and European economies remain weak, which is hitting overall demand and curtailing traction in the premium space where FedEx gets its gravy. The TNT integration, while progressing, still remains a $350 million problem for the fiscal year. Total integration costs were raised to $1.7 billion from $1.5 billion. Smith continued to impress upon analysts that the 2017 “NotPetya” state-sponsored cyberattacks in 2016 and 2017 against TNT Express, among other companies and institutions, remain a burr in the saddle. The attack crippled TNT Express’ I.T. network and, ultimately, its physical network, costing FedEx about $300 million to dig out of the hole.
For all FedEx’s challenges, perhaps its biggest long-term is making U.S. e-commerce deliveries consistently profitable when lengths-of-haul continue to shrink as retailers fulfill closer to the end customer. Shorter hauls means the company gets paid less-per-package. Smith noted the trend, and cautioned that the “average yields have to be matched with operational changes, not visible to most to assess, to ensure future profitability.” Smith rejected suggestions that FedEx’s operational structure is not compatible with the demands, saying his company is “perfectly built for e-commerce.” He added, however, that “we have to be more efficient” in execution.
FedEx did not provide an earnings per-share forecast for the current fiscal year, though it said that EPS will decline by mid-single digits over FY 2019’s level of $15.52 per adjusted share. (At one time, consensus FY 2020 estimates were $16.23 a share). Based on that roadmap, analysts chopped estimates for FY 2020 and 2021. Amit Mehrotra of Deutsche Bank cut his FY 2020 earnings per share forecast to $14.80, about a 5 percent year-over-year decline. Mehrotra also reduced his view for revenue growth to 3.2 percent, down from his previous forecast of 4.7 percent growth. Bascome Majors of Susquehanna Financial Group trimmed his forecast to $15 a share from $15.60, and his FY 2021 outlook by 50 cents a share to $17 a share. Todd Fowler of KeyBanc Capital Markets dropped his EPS view to $14.75 from $15.75, and rolled out a FY estimate of $16 a share.
Kevin Sterling of Seaport Global Securities may have wielded the sharpest ax, taking estimates down to $14.59 to $14.90 from $16.64 a share. “It wasn’t that long ago that there was a belief FedEx could earn $20 a share in FY 2020,” Sterling said, noting, as has everyone else, that times have changed.
FedEx has a lot to prove as far as Wall Street goes. Analysts are willing to give it the benefit of the doubt given its long and mostly illustrious earnings history. Yet the recent developments “make it hard to defend shares,” Mehrotra wrote in a note. Majors said FedEx will “remain in the valuation `penalty box’ as long as macro and trade conditions worsen and investors stay concerned about free cash flow levels due to significant costs in building out the U.S. and international networks, he said.
At the same time, FedEx shares are discounting as much bad news as can be out there, and valuations sit at multi-year lows relative to the S&P 500. Patient investors looking for a bottom may have found one, according to Majors. Fowler, who has an “overweight” rating on the shares with a 12-month price target of $190, said investor expectations are so low that a brightening macro picture combined with even slightly better-than-expected results could be “viewed as meaningful positives.”