FedEx: Cyber Attack Fallout

| About: FedEx Corporation (FDX)


FedEx is out with an update on the TNT cyberattack.

A discussion of revenues and potential impacts.

Adjusting my estimates.

FedEx Corp. (NYSE:FDX) shares are on watch today as we just learned of an update regarding the cyber attack of the TNT express segment last month. Seems there will be a significant financial hit here. Let me remind you that back in June, TNT was significantly affected due to the infiltration of an information system virus. TNT Express operations and communications systems were disrupted for an extended period of time but no known data breach with customer data was known to have occurred. However, the name is still reeling from the attack as there are invoicing delays and other shipping hold ups. Shares were halted when it occurred. What is important to note is that the operations of all other FedEx companies were unaffected. However today the company said it will see a “material” impact. Translation: prepare for a revenue and earnings miss this quarter.

In today’s update, we learned that all TNT depots, hubs and facilities are operational and most TNT services are available, but the delays persist. Further, manual processes are being used to facilitate a significant portion of TNT operations and customer service functions, effectively taking the company back 20 years technologically. Here is the real kicker: the company “cannot estimate when TNT services will be fully restored”. This means we can expect a severe impact to expected revenues. The company acknowledged this, stating:

“We are still evaluating the financial impact of the attack, but it is likely that it will be material. We do not have cyber or other insurance in place that covers this attack. Although we cannot currently quantify the amounts, we have experienced loss of revenue due to decreased volumes at TNT and incremental costs associated with the implementation of contingency plans and the remediation of affected systems.”

What is interesting is that despite the impact to revenues which it knows will be sizable, it reaffirmed that it will improve operating income by $1.2 billion to $1.5 billion in fiscal 2020 versus fiscal 2017, assuming moderate economic growth. However, this year is likely going to take a big hit. Looking back to last quarter, the TNT Express segment reported strong revenues. Excluding any integration expenses and restructuring charges, TNT Express saw revenues of $1.91 billion. Operating expense was high, and weighed on margins. As reported the GAAP operating income was just $26 million, with margins of 1.4%. Factoring in some adjustments, operating income was $83 million, with margins of 4.4%. While these revenues pale in comparison to the big money maker that is the FedEx Express segment, which saw $7.18 billion in revenues last quarter, a hit to TNT is a hit to overall expected performance.

With some back of the napkin estimates, I would say a worst case scenario is a 30% hit to revenues, and at $2 billion in sales, this equates to roughly a max $650 million hit in the quarter for sales. To be clear, I expect it to be less, but it stands to reason that with TNT moving to “manual processes,” that segment expenses will be greater than anticipated. Thus, I expect a hit to the bottom line, perhaps on the order of $0.20 per share. I arrive at this number using Q1 numbers, assuming worst case scenario of a $650 million hit to revenues, which were $15.7 billion last year and estimating a 5%-15% bump in expenses in the TNT segment. Again, just a guesstimate. Whether the company is able to somehow absorb the expenses by cutting elsewhere remains to be seen.

Obviously this is awful news. With shares at a 52 week high coming into today, expect some big profit taking. Independent of this attack, I was already expecting a few quarters of continued pressure on margins as TNT was integrated. While it is true that the company expects to incur significant expenses over the next few years in connection with the integration of TNT Express and the Outlook restructuring program, the future is bright, once we escape the plight of this attack. Looking ahead to all of 2017, FedEx has not adjusted guidance. While before this attack I was expecting adjusted earnings to be somewhere in the $11.80 to $12.20 per share range, I now am reducing my estimates to $11.65-$12.05.

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