FedEx Corporation's (FDX) share price has been under pressure as it faces headwinds resulting from the current trade war.
I view FDX as a leader in the Air Delivery and Freight Services industry.
Its current attractive valuation presents long-term investors with a window of opportunity to invest in a high quality company which should benefit from the projected growth in e-commerce.
- FDX reported Q4 and FY2019 results following the close of business June 25th.
- Decisions made in Washington have had a significant detrimental impact on FDX which has led to FDX filing suit seeking to enjoin the U.S. Department of Commerce from enforcing prohibitions contained in the Export Administration Regulations.
- Despite new competition from Amazon.com and Uber Technologies I view FDX as one of the premier companies in the Air Delivery and Freight Services industry.
- There is no indication as to when current headwinds which have depressed FDX’s share price will subside but I view FDX as an industry leader which has fallen out of favor with the broad investment community and whose shares are now attractively valued.
When I analyze a company I take into consideration that macro events can have a negative impact on a company’s short-term investment performance. I also look at the extent to which the company being analyzed could be impacted by the entry of new competitors (eg. Amazon.com (AMZN) and Uber (UBER)).
Subsequent to my December 19th FedEx Corporation (NYSE: FDX) article, FDX has continued to experience significant challenges. The global trade environment continues to deteriorate and circumstances have become so dire that more than 300 companies are talking to government officials in Washington about how detrimental the trade war between the U.S. and China has been and will be to their business.
FDX has gone one step further than most other companies having resorted to filing suit in U.S. District Court in the District of Columbia on June 24th seeking to enjoin the U.S. Department of Commerce from enforcing prohibitions contained in the Export Administration Regulations (“EAR”) against FDX; here is the explanation from FDX’s CEO and Chairman regarding the lawsuit.
On June 25th, FDX released Q4 and FY2019 results in which it reported better-than-expected Q4 earnings amid stiff competition from rival UPS (UPS). In the conference call with analysts, FDX’s CFO stated that FY2020 performance is being negatively affected by continued weakness in global trade and industrial production, especially at FedEx Express.
In addition, the investment community was advised that macroeconomic weakness and trade uncertainty, a continued mix shift to lower-yielding services and the decision to not renew an AMZN contract will negatively impact operating income at FedEx Express. I do not view this decision as it relates to business conducted with AMZN as an entirely negative event. FDX made this decision as part of its plan to focus on serving the broader e-commerce market. I also note that FDX has indicated that existing contracts between AMZN and other FDX business units, or relating to international services, are not impacted.
Furthermore, AMZN is not FDX’s largest customer. The percentage of total FDX revenue attributable to AMZN represented less than 1.3% of total FDX revenue for the 12-month period ending December 31, 2018.
In making the strategic decision to exit the U.S. domestic contract with AMZN, FDX took the position that there is significant demand and opportunity for growth in e-commerce; growth from 50 million to 100 million packages a day in the U.S. is projected by 2026.
On the June 25th conference call with analysts, FDX’s Chairman and CEO indicated that in order to substantially grow its e-commerce business and improve profitability, FDX will need to become increasingly efficient in delivering residential packages and will need to drive down costs to serve this market. In this regard, FDX recently announced in-sourcing 2 million SmartPost packages and it also reached an agreement with Dollar General (DG) for over 8,000 pickup and delivery on-site locations with several additional initiatives pertaining to the growth of this area of FDX over FY2020.
In fact, once the DG rollout is complete the number of retail locations providing staffed FDX shipping will grow to over 27,000; this alliance brings FDX closer to the consumer than ever with FDX now within 5 miles of over 90% of the US population.
In addition, FDX has recently announced a number of innovative solutions for its FedEx Ground network such as:
- 7 day a week residential delivery;
- The rapid integration of FedEx SmartPost volume into standard ground operations;
- The enhancement of network capabilities around large package handling.
These changes directly address some of the key challenges inherent with e-commerce (ie. increasing consumer expectations and managing the cost for residential delivery). By bringing the SmartPost volume into the ground network FDX can improve density and efficiency in the Last Mile deliveries; FDX expects FedEx Ground to become the low cost Last Mile provider in the industry.
FDX expects to have a large package operation in nearly 40 Ground facilities prior to its peak season (late 2019) with the vast majority of these ground facilities being existing facilities; this approach minimizes CapEx and enables FDX to focus on placing large package handling in strategic locations which are close to ports and railroads.
In order to remain at the forefront of its industry FDX has been investing heavily in technology. The freight industry has historically been paper based and by updating its systems to incorporate the latest in technology, I envision FDX will be able to greatly benefit from near real time data since it will be easier to maximize the use of rail, improve delivery density and increase the efficiency of handling all packages.
The technological enhancements and state of the art tools are being implemented across all FDX operations. FedEx Freight, for example, is in the midst of adding technological advancements like advanced forklift computers, electronic shipping labels, and advanced driver assist systems.
At FedEx Express, initiatives are being implemented to lower the cost to serve the US market. In fact, a multi-year hub modernization program has been launched at two FedEx Express hubs which is expected to enable FedEx Express to handle more volume more efficiently.
Although the global trade picture presents considerable challenges, FDX continues to move forward with the integration of TNT; FDX is now beginning FY2020 with a global sales force that is 98% integrated.
In my opinion, the FDX of today is very different from the FDX of 10 years ago and what it will be 10 years in the future. I, therefore, caution investors to be very careful when extrapolating past assumptions and trends into the future.
FDX has noted that short haul package delivery will become increasingly important as retailers ship e-commerce orders from its stores. As a result, the average yields will need to be matched with changes which are not clearly visible when assessing FDX’s operations.
FDX also expects future developments will speed up e-commerce deliveries and postal reform thus resulting in discontinuities in the next several years.
Despite all the enhancements FDX is making to become more efficient and profitable in the long-term, I can appreciate how many investors will look at the global trade headwinds and the rapidly changing environment in which FDX competes and will wonder whether FDX will be a wise investment over the long-term. In my opinion, the changes FDX is making are critical and will benefit the company over the long-term.
I completely agree that FDX will most likely continue to face significant short-term headwinds which could result in less than stellar results over the coming quarters. I, however, continue to view it as a high quality company with a bright long-term outlook and have acquired additional shares for the FFJ Portfolio at ~$158/share. (cont'd.)
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Disclosure: I am long FDX.
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