2023-12-20 15:43:35 ET
Summary
- FedEx stock dropped after disappointing earnings results, as management is now guiding for revenues to decline for the full-year.
- The company's cost-cutting programs have helped offset revenue declines, but these measures are unsustainable in the long term.
- One must question why revenues continue to be pressured even as the company laps easy comparables.
- It is time to downgrade the stock.
FedEx ( FDX ) saw its stock drop double-digits after reporting disappointing earnings results. The company delivered solid growth in earnings but experienced pressure on the top-line. After seeing revenue growth decline last year due to lapping tough pandemic comparables, it is concerning that FDX continues to expect revenues to decline yet again this year. While the company has been able to more than offset disappointing revenue numbers with expanding profit margins due to its cost cutting programs, such levers are inherently unsustainable and are unlikely to come to the company’s rescue in future years. The stock is not terribly expensive at around 14x this year’s earnings, but the valuation looks appropriate given the capital intensity as well as competitive pressures. I am downgrading the stock from “buy” to “hold.”
FDX Stock Price
FDX has struggled to hold onto pandemic gains and is even trading lower than 2018 levels.
I last covered FDX in September of 2022 where I rated the stock a buy in spite of some earnings hiccups. The stock has delivered stellar returns since then, in large part due to multiple expansion. It is time to downgrade the stock given that the valuation no longer appears as compelling.
FDX Stock Key Metrics
In the most recent quarter, FDX saw revenues decline 3% YoY but earnings per share grew 25%. The company has been executing against its cost optimization program DRIVE which in conjunction with the ongoing share repurchase program help to explain the discrepancy.
FDX saw the greatest pressure in its Express segment as management on the conference call blamed a slew of headwinds from lower fuel surcharges, reduced demand surcharges, as well as increased use of ground services by the USPS.
We can see below that FDX has been pressured by declines in package volume.
While FDX was able to deliver solid operating margin expansion in its ground and freight segments, the express segment saw operating margins come in at a paltry 1.7%. That result is not too surprising - FDX is basically having to operate using the same fleet and infrastructure but with less revenues. The company’s slim profit margins means that operating leverage can work in the opposite direction when revenues are pressured.
Management continues to guide for CapEx to decline as a percentage of revenue over time. The company had previously been known for egregious spending on CapEx that was so aggressive that the company was burning cash on a consolidated basis . Nowadays, FDX is generating solid free cash flows and has been able to repurchase shares using retained cash flows.
Management reaffirmed their earnings outlook of between $17 and $18.50 per share for the full-year, but is now expecting revenues to decline by a low single digit percentage. Investors should focus on the disappointing top line number for two reasons. First, the bottom-line is benefitting from the cost optimization program but there are only so many costs that can come out of the business. Second, FDX had already seen revenues contract double-digits last year as the company lapped tough pandemic comparables. This year in theory should have seen those tough comparable headwinds turn into easy comparable tailwinds, but instead the company is expecting another year of declines.
At the same time, the cost optimization efforts can help drive strong earnings growth in the event that revenue growth can pick up next year, as the company will be able to operate from a leaner cost position. On the conference call, management noted that they are in active negotiations with regards to negotiating a renewal of their contract with the USPS. Management noted that it “will take quite a significant change in contractual terms and agreement to renew that contract,” but it is not entirely clear to me if FDX has the upper hand in negotiations. According to their 2023 10-K , that contract expires in September of 2024.
Is FDX Stock A Buy, Sell, or Hold?
After the decline, FDX was trading at around 14x earnings. Consensus estimates still expect FDX to come in at the high end of earnings guidance, but it is possible if not likely that analysts eventually revise their estimates downward.
It was much easier to recommend buying FDX in my prior report when the stock was trading at just 10x earnings. Amazon ( AMZN ) continues to dominate the e-commerce space and I see that dominance only continuing to grow as the company builds on its logistics infrastructure advantages year after year. With UPS ( UPS ) being AMZN’s chosen partner, FDX faces long term existential risk if AMZN continues to take market share. That kind of risk might not have mattered so much if the stock was trading at 10x earnings, but at 14x earnings, the stock will need secular growth in order to justify the valuation. From a macro perspective, it appears that inflationary pressures may be easing, but that might also make it more difficult for the company to raise prices. The company has been able to offset declining shipment volumes with its price increase, but that ability may ironically diminish upon a decline in interest rates. The company does not appear to have visible catalysts to accelerate revenue growth, and does not trade at compelling valuations. I am downgrading the stock to “hold” as this higher interest rate environment is demanding of lower valuations.
For further details see:
FedEx Falls 10% After Earnings: Why I Am Downgrading The Stock