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Following the release of FedEx's (FDX) Q2 2019 less than stellar results after the close of business on December 18th, the investment community shaved ~12% from FDX's stock price on December 19th.
Weak FedEx Express results were reported due to international revenue challenges driven by international economic weakness.
Projected earnings for the remainder of the current fiscal year were revised lower.
FDX is instituting several significant cost reduction programs, is re-evaluating its capital spending going forward, and all aspects of FDX’s financial plans are under review.
Summary
- FDX released Q2 and 1st half FY2019 results following the close of business December 18th.
- FedEx Express trends worsened in Q2 primarily due to international revenue challenges driven by international economic weakness.
- FDX is instituting several significant cost reduction programs, is re-evaluating its capital spending going forward, and all aspects of FDX’s financial plans are under review.
- I view FDX as attractively valued and have acquired additional shares following the ~12% pullback on December 19th.
Introduction
In my December 11th FedEx (NYSE: FDX) article I noted the following in my ‘Final Thoughts’:
‘The recent announcement, in the midst of the crucial holiday season, that FedEx Express’s CEO will retire effective Dec. 31, 2018 after just two years at the helm has certainly raised some concern that something is awry at FDX. This has resulted in FDX’s share price getting slammed.
I view this as a ‘speed bump’ and I do not think that FDX’s business has been permanently impaired.
I fully recognize that the investment community could get a surprise when Q2 results are released December 18th but based on FDX’s history it is not in the business of surprising investors. We may see some weaker than expected results which might be attributed to some of the political turmoil but I think Tariff Man’s days are limited and global trade will be stronger once he is gone; this would bode well for FDX.’
Sure enough, in FDX’s Q2 Earnings Release following the close of business on December 18th we learned that ‘at FedEx Express, operating results were negatively impacted during the quarter by lower-than-expected international revenue, especially in Europe and Asia’.
Mr. Market has certainly not reacted kindly to the Q2 results and lower FY2019 projections; on December 19th FDX’s share price closed ~12% lower at ~$162.50 from the December 18th close.
Q2 and YTD FY2019 Results
FDX’s Q2 Earnings release can be found here.
On the December 18, 2018 Q2 earnings call with analysts, FDX indicated:
‘As our volumes and revenues demonstrate, FedEx is experiencing strong growth in the U.S. where the economy remains solid. However, our international business, especially in Europe, weakened significantly since we last talked with you during our earnings call in September. In addition, China's economy has weakened due in part to trade disputes. As a result, we have lowered our fiscal 2019 earnings guidance and are accelerating actions to reduce costs given the uncertainty of global macroeconomic trends. We are highly confident that we will achieve the benefits expected with the acquisition of TNT Express, although we will not achieve our FedEx profit improvement goal in fiscal 2019.’
‘The secular slowdown in Chinese economy has been exacerbated by trade tensions. Spillover effects from these tensions and the fading tech cycle have negatively impacted growth throughout Asia. Emerging Asia growth slowed from 6% in 2017 to 5.6% in Q3. World trade slowed in Q3 to just 3.5% compared to 5.3% in Q3 2017. Leading indicators point to positive but even slower trade growth near term.’
FDX has indicated it will continue to improve its productivity through various programs, including the expanded use of technology and capitalizing on efficiencies available through the scale of its network as it integrates operations in Europe and gains market share at FedEx Ground.
Following TNT's recovery from the well publicized cyber attack, there has been an accelerated shift of FDX’s product mix to more freight than parcel. This has put pressure on costs.
The continued tariff and trade concerns and uncertainty in Asia are impacting FDX’s business and FDX is working with its customers as they re-evaluate their supply chains.
FDX has accelerated the integration of its sales force by 1 full year; ~70% of the global sales force has been integrated with the remainder to be completed at the end of FY2019.
In addition, it has accelerated investments in its IT systems and infrastructure to strengthen and enhance and protect the systems used to run the daily operations; FDX is integrating its 2 global network businesses.
The integration to date has focused on smaller markets which represent ~30% of volumes. The remaining integration work is focused on much larger, more complex, and direct serve markets. In essence, the countries that deliver most of the benefits from the integration of the TNT and FDX systems are weighted to the later stages of the integration due to the complexities of their business so the significant benefits are expected to be generated toward the end of the integration.
FY2019 Guidance
Revised FY2019 guidance can be found in the December 18th Earnings Release. The key takeaways are that:
- Earnings of $12.65 - $13.40/diluted share before year-end MTM retirement plan accounting adjustments. This is down from the prior forecast of $15.85 - $16.45/diluted share;
- Earnings of $15.50 - $16.60/diluted share before year-end MTM retirement plan accounting adjustments and excluding TNT Express integration expenses, charges related to a FedEx Ground legal matter, charges associated with the voluntary employee buyout program and the revision to the provisional benefit from the remeasurement of the net U.S. deferred tax liability included in fiscal 2018 earnings. This is down from the prior forecast of $17.20 - $17.80/diluted share.
FedEx is unable to forecast the fiscal 2019 year-end mark-to-market retirement plan accounting adjustments. As a result, the company is unable to provide a fiscal 2019 earnings per share or effective tax rate outlook on a GAAP basis. This is no different than every other quarterly earnings release provided by FDX so I do not view this as a cause for concern.
The lower guidance is due to a shift in business conditions and service mix at Express, primarily in Europe. In addition, FDX is no longer providing guidance for revenue growth and operating margin for FY2019.
On the conference call with analysts, management stated that:
‘FedEx Express trends worsened in the second quarter, primarily due to international revenue challenges, driven, of course, by international economic weakness. While international revenue was still growing, it is not growing at the rate we expected because of the overall global economic uncertainty that Raj just mentioned. Some of the largest economies in Europe are experiencing weakness. That is impacting our international business. Germany, for example, saw their GDP contract quarter-over-quarter in the third calendar quarter. Italy remains a drag on overall Eurozone growth. The unrest in France, and I was just there two weeks ago, continues to escalate and spread with yellow vest protest now inspiring similar actions in Belgium, The Netherlands, Germany, and of course, throughout all of France. Also, the uncertainty of the United Kingdom with their Brexit issue.’
In order to address these headwinds, a voluntary buyout is being offered to eligible U.S. employees. This is expected to cost $0.45B - $0.575B and will be recognized primarily in FY2019 with a lesser amount in FY2020. As previously noted, this voluntary buyout will have estimated savings of $0.225B - $0.275B commencing in FY2020; this translates into a ~18 - 24 month payback. A similar voluntary buyout program is being considered in FDX’s international operations.
Furthermore, FDX will be:
- instituting capacity reductions primarily in its international airline network;
- limiting hiring in staff functions;
- reducing discretionary spending.
FDX is forecasting an effective tax rate of 24% - 25% for FY2019 before year-end mark-to-market retirement plans and accounting adjustments.
The capital forecast of $5.6B remains but FDX is re-evaluating its capital spending going forward.
Over the last 5.5 years FDX has spent ~$11.6B to repurchase ~76 million shares resulting in the ~18% reduction in outstanding shares. Regrettably, FDX repurchased nearly $1.3B of its shares during the first half of the current fiscal year when its share price was well in excess of current levels.
All aspects of FDX’s financial plans are under review including whether it will repurchase additional shares this year.
Valuation
In reviewing how FDX’s stock price has behaved over the past several years we see that it reached a low of ~$64 in September 2011. Diluted EPS for the most recent quarter prior to this low (Q1 which ended August 31, 2011) was $1.46 (page 5 of 48 of 10-Q). By the end of that fiscal year, FDX had generated diluted EPS of $6.41.
If investors had acquired shares at ~$64 then that was a pretty attractive price for a company which ended up generating $6.41 for the year (diluted PE of ~10).
Looking at FDX’s share price by the end of 2011 we see it rose to ~$83 which ends up being a diluted PE close to 13 based on the $6.41 FDX ended up generating for the year.
Let’s look at January 2016 in which FDX briefly traded close to $126; this is another period in which FDX’s share price was low relative to previous levels. Here is a link to FDX's 10-Q that was released just prior to that low point. Note how 6 month diluted EPS was $4.86 (page 5 of 266). If you look at FDX’s 10-K for the year you see that Diluted EPS for the full year ended up coming in at $6.51 (page 44 of 244).
If we use the $126 stock price and the $6.51 in diluted EPS FDX ended up generating for FY2016 we get a diluted PE of ~19.35.
FDX is now trading at ~$163 and diluted EPS for the first half FY2019 amounted to $6.60. Let’s surmise that in the second half of the current fiscal year FDX will generate $3.40 in diluted EPS giving us full year diluted EPS of $10. This means that FDX’s forward diluted PE is ~16.3.
This level is certainly not as low as in 2011 but is somewhat better than the 2016 level and is certainly far better than the ~27 average over the past 5 years.
Final Thoughts
Could FDX drop further in value and we get a diluted PE level closer to the low teens? Given that FDX’s significant cut in its guidance for FY2019 suggests a severe recession is not out of the realm of possibility then a PE in the low teens should not be ruled out entirely.
In my opinion, FDX is one of the premier global courier companies. While current results are weaker than anticipated I fully expect business conditions to significantly improve at some future point in time.
I have no reason to suspect that management will not take the appropriate course of action to ensure FDX is able to adapt to a weaker environment while, at the same time, continuing to invest in the business at a prudent level to ensure it remains one of the premier courier companies in the world and to be in a strong position to benefit from e-commerce growth.
I have, therefore, acquired additional shares for the ‘side accounts’ within the FFJ Portfolio following the significant pullback on December 19th.
I hope you enjoyed this post and I wish you much success on your journey to financial freedom.
Thanks for reading!
Note: I sincerely appreciate the time you took to read this article. Please send any feedback, corrections, or questions to [email protected].
Disclaimer: I have no knowledge of your individual circumstances and am not providing individualized advice or recommendations. I encourage you not to make any investment decision without conducting your own research and due diligence. You should also consult your financial advisor about your specific situation.
Disclosure: I am long FDX.
I wrote this article myself and it expresses my own opinions. I am not receiving compensation for it and have no business relationship with any company whose stock is mentioned in this article.
