Industrials, after expecting a slow growth in sales for this year, have started to think about cost restructuring in order to maintain their profit levels. Harley Davidson (NYSE:HOG), Navistar (NYSE:NAV) and Detroit automakers Ford (NYSE:F) and General Motors (NYSE:GM) are some of the examples in this regard. Cummins (NYSE:CMI), a truck engine manufacturer, announced the same in its press release released recently. Structural changes in FedEx (NYSE:FDX) were already being expected by the market for some time now. The announcement regarding cost savings was made during an investors meeting last week; this was one of the few catalysts mentioned in our report after the earnings release.
Since the announcement, the stock is up around 6% since investors hardly expected such a big improvement in profits, which FedEx claims to make by 2016. Analyst high-end estimates of $1 billion were much lower than FedEx's announced $1.7 billion. The bottom line improvement will come from both revenue improvement as well as cost cutting. The company broke down the figure into five buckets, of which about $1.2 billion will come from cost-cutting initiatives, while the remaining will be generated through revenue growth within the Express division, from where the company already gets 62% of its total revenues.
About $1.55 billion of the overall $1.7 billion improvement in profitability is expected to come from the Express division. FedEx has realized that people are no longer willing to pay more for an overnight delivery service. They would rather wait another day for the goods to be delivered, instead of paying a premium for quicker delivery. The important thing, according to the market, is that the change in customer preferences and attitude is one that has less, or nothing, to do with the recession. More or less, the change is secular, and therefore the structural change made by FDX will be a permanent one. The company will not revert to how it used to do things once the economy improves. According to the head of the Express unit, Dave Bronczek:
"We look at the world differently now. We're more conservative."
An improvement of around $300 million will come from modernizing the air fleet. Boeing's (NYSE:BA) 757 and 767 planes will be used as replacements, which will allow fewer flights, and will carry more cargo than old fuel-inefficient jets. Another $350 million will come from changes in the domestic Express business, which includes replacements of 5,000 fuel inefficient vehicles.
Companywide savings worth $1 billion will come from job cuts. Several thousand employees are expected to accept the voluntary buyout offered in August this year.
It will be interesting to see when FDX expands its international business. It is quite against the norm of the industry, where businesses tend to solidify their local operations first and then think of expanding their international businesses. The recent announcement by Navistar, the truck and engine manufacturer, regarding curtailing a large part of its international business, is a case in point.
However, the expansion announcement by FDX can be justified by the fact that the international side of its Express business is a growth story. The growth has come because of the recent business acquisitions in different parts of the world like Brazil, France and Poland. A senior VP of global marketing described the international business as the "crown jewel" of the company.
The company will also expand its ocean shipping business, providing a larger variety of services, and will invest in improving its infrastructure in Europe. The company will use technology to boost efficiency across its operations.
In the analyst meeting, FedEx reiterated the forecast that it had given in its last earnings release. Earnings are expected to be $6.2-$6.6, reduced from the $6.9-$7.4 figure given before the earnings release of the first quarter.
It is important to note that the overall economy is not giving a clear signal. After all, economic growth boils down to one cause - consumer sentiment. Where FedEx has reduced its employees in anticipation of a negative consumer sentiment in the future, Wal-Mart (NYSE:WMT), the retail giant, has announced that its back-to-school sales were strong, and annual retail sales are expected to grow by 7%, which obviously shows that consumer spending is on a rise.
It is also obvious that many industrials are cutting down or have already cut down their costs to the bare minimum, and top-line growth will be needed to maintain profits in the future.
After announcing expectations of massive improvement in profitability, Citi increased its price target from $99 to $108. Also, Standpoint upgraded FDX to buy. The announcement has led the market to favorably revise the multiples. Given the improvement in the cost structure of FDX's main business, the stock is recommended as a buy, as in our earlier thesis.
Earlier on, we had a sell recommendation on the stock. The main reason behind that was the poor performance of FedEx's main segment - i.e. Express. Now that the company has decided to restructure the whole department, the stock is expected to go up and we are changing our recommendation to buy.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: The article has been written by Qineqt's Industrial Analyst. Qineqt is not receiving compensation for it (other than from Seeking Alpha). Qineqt has no business relationship with any company whose stock is mentioned in this article.