In the long run, FedEx (FDX) is a story of growing revenues, profitability, and margins both in the U.S. and across the globe. All of its four segments -- express, ground, freight, and services -- are expected to bring big business to the company.
However, in the short run the mild economic situation in the U.S., the troubled European economy, soft demand from emerging economies, and a slashed outlook from one of its peers do not reflect optimism for FDX investors. The company has also announced it will offer voluntary buyouts, which shows that the company is planning to cut costs amid declining growth in revenues.
Apart from the cyclical downturn, the transportation Industry is facing high fuel costs, which have put operating margins under severe pressure. The company is replenishing its fleet and is streamlining its operations, which is expected to save $900 million. Switching to natural gas powered vans is also a significant opportunity for the company to save costs, as natural gas prices have plummeted to record lows after the shale gas boom.
The restructuring plan will take a couple of years before generating cost savings. Given the current circumstances, as explained above, and the fact that the company's closest competitor, United Parcel Service (UPS), missed earnings this quarter, there is a solid chance that FDX will also follow suit. Therefore, the stock is recommended as a short until the earnings release.
Earnings Preview and Peer Analysis
The following are the expected earnings and revenue figures for the first quarter:
The company has beaten earnings for the last four consecutive quarters. However, this time around, the economic circumstances are not as promising as before. The company's peers have also shown a bearish attitude toward the end markets. UPS cut its Asian network by 10% due to weak exports to Asia. It claims that U.S. GDP will grow by only 1% in the second half of the year. Therefore, it slashed its EPS forecast from $4.75-$5 to $4.5-$4.7. It also missed second-quarter earnings by 1.7%.
FDX, although, has not been that bearish about the U.S. market. The management claims that there will be moderate growth in the economy. In June, it disclosed that it expects the U.S. economy to grow by 2.2%, higher than the 2.1% it predicted some three months earlier.
Operations and Outlook
The following shows the operations of FDX and briefly state what they do:
Click to enlarge images.
The following shows the segment-wise revenue:
The chart shows that Express is the most revenue generating unit of the company, which makes 70% of its revenues from the U.S.
The following shows the operating income from each segment:
The Services segment is incurring operating losses.
Two important drivers for Express and Ground Deliveries are package yields and package volumes. Where volumes are the units of packages to be delivered, yield is the revenue per package. In this quarter, U.S. domestic volumes fell year over year due to a weak economy, while yields rose due to an increase in fuel surcharge and increased rate per pound. U.S. domestic yields rose by 10%, whereas international yields rose by 8% year over year.
The following shows the performance of the division over the year:
FDX is the world's largest express company. Not only this, it is the world's largest air cargo carrier with the most freight ton-kilometers flown. This segment accounts for the largest chunk of international revenues.
The future seems to be bright for this segment. The division opened 38 stations in Europe this year, despite a weak economy in the continent. The yield rates are on the rise as well; they increased by 6% year over year this year. The division is focusing on improving margins by replenishing the air fleet to be replaced by more efficient Boeing (BA) jets. The segment plans to replace 54 jets from 2014-18. The fleet replacement is discussed in detail below. The operating margin declined by 20bps to 4.8%. It is expected to rise due to productivity enhancements and cost cutting plans, such as voluntary buyout offers.
This segment is growing the most in terms of market share, as the segment has managed to shorten transit times in the U.S. and Canada, by accelerating various lanes. This segment not only witnessed a 7% rise in yield, but also witnessed growth in volumes due to the competitive advantage it enjoys, as mentioned above. The market share also rose as the company managed to dramatically bring down package loss rates and damage claims.
As a future outlook, revenues are expected to rise as the division manages to win a larger market share. It also plans to automate loading and delivery processes, which will lead to improved productivity. Capital expenditures are also expected to rise in the form of increased spending on purchases of vehicles. Operating margins improved by 280bps in 2012 to reach 18.6%.
The yields improved by 7% in 2012. However, given the declining economy, the trucking business has been severely influenced. Fortunately, as compared to the normal Full Truck load carrier, the LTL version has been more immune to the recession. Still, shipments fell by 1% in 2012 for this division. The segment benefited from mild winters.
Revenues are expected to rise as utilization rates improve on a global economic recovery. An increase in capex to achieve increased operational efficiency will help improve margins.
Voluntary buyouts were announced for employees of Express and Services. As already mentioned, the Express division is undergoing a heavy cost-cutting program, where vehicles are being replaced and the headcount is being reduced. The pool is a huge one. There are 102,000 employees in the domestic express business and 12,500 employees in services. The employee reduction program is a significant part of the company's overall restructuring policy. A 7%-9% acceptance rate of the pool is expected, which will lead to savings of $250 million per annum.
The company wants to enhance operating margin from 7.7% to above 10% by switching from old airplanes to more fuel-efficient planes. The switch from 727s to 757s and MD10s to 767s is expected to bring in $250 million in five to six years by saving fuel and maintenance costs. FDX also plans to reduce its domestic fleet capacity by 10% by 2018, which will save an additional $950 million.
Shale Gas Boom and the Opportunity
The declining natural gas prices and rising fuel prices have provided a massive opportunity for transportation companies to switch to the cheaper source of fuel. Following shows the potential savings that FDX can enjoy if it switches to the alternative fuel:
(Qineqt's estimate. The aircrafts may not be run on natural gas. Given that FDX has a fleet of 40,000 pickvans, (at incremental $11,000) approximately incremental capex comes out to be $440 million. Incorporating that still gives a positive NPV.)
Companies like FDX and UPS are bellwethers of the economy. Falling growth rates and volumes for FDX segments show the conditions that the economy is going through. FDX's return has underperformed the S&P 500 since the last three months.
However, the company has no liquidity problems. Overall, margins are on a rise. The stock is almost 5% up year to date. It pays a dividend yield of 0.6%. The cash flow from operations is positive. The transportation business is evergreen and is only down because the U.S. economy is going through recessionary times. Having said that, it is also important to consider competitors' view, who have slashed this year's outlook and missed this quarter's earnings. Also, the recent buyout offers in FDX's largest division (Express) have made investors doubtful.
The stock is trading a forward multiple of 10 times. The earnings are expected to increase by 14% per annum for the next five years. However, given the cyclical nature of the stock, chances are that there will be some better entry point for investors to take a long position in the stock. In this context, the earnings release on Sept. 18 will be an important catalyst. Given the current situation, the stock is recommended as a short until the earnings release.