2023-04-26 12:25:03 ET
Summary
- FedEx Corporation stock has risen over 27% this year amid the improving sentiment toward risk assets.
- FedEx has implemented strategic measures to optimize its operations and improve financial performance, including cost-cutting, efficiency enhancements, and right-sizing its overall cost structure.
- The investment thesis for FedEx is less about its business reorganization and more about favorable long-term macroeconomic trends.
- Based on recent developments discussed in this analysis, I am convinced Wall Street analysts will hike their fiscal 2024 EPS estimates higher in the coming months.
FedEx Corporation ( FDX ) stock is up more than 27% this year amid the improving sentiment toward risk assets. Last June, when FDX was trading around $229, I was wary of investing in the company because of the operational challenges that were coming to light. No regrets there, and when the stock crashed to around $150 last September, I felt good about not investing in the company earlier. What I do regret is not pulling the trigger to invest in FedEx stock last September despite identifying the long runway for growth. At the time, I thought the company would suffer from a notable contraction in operating margins, and I was wary of the heating-up competition in the industry, too. Although operating margins declined as expected, they held up better than I expected. What I did not anticipate was a dramatic improvement in Wall Street earnings estimates for 2023 and 2024 - more on this later.
After evaluating the recent strategic initiatives, the macroeconomic outlook for the company, and FedEx Corporation's sensitivity to earnings revisions, I believe FedEx stock will maintain the current positive momentum.
Overcoming Challenges and Driving Cost Savings
In an effort to address challenges and drive cost savings, FedEx has implemented a series of strategic measures to optimize its operations and improve financial performance. With a focus on cost-cutting, efficiency enhancements, and right-sizing the overall cost structure, FedEx has taken significant actions to mitigate the impact of economic and service-related challenges, particularly in Asia and Europe.
To address cost challenges, FedEx announced the closure of 90 office locations and five corporate office facilities, deferred hiring efforts, reduced flights, and canceled projects last year. These measures were aimed at optimizing the company's cost structure and aligning it with the evolving demand conditions. While the company faced specific weaknesses in Asia and challenges in Europe, which resulted in softening shipping volumes and high operating expenses, FedEx took decisive steps to generate substantial cost savings and improve its financial outlook while positioning the company to be more nimble in the future.
One of the key areas where FedEx is driving cost savings is in its Express division, which is expected to generate $1.5 billion to $1.7 billion in savings in FY 2023. The company is making changes to its express air network, including reducing global flight hours by 11% of planned specific daily frequencies, 9% of transatlantic daily frequencies, and 17% of daily frequencies between Asia and Europe. These adjustments are aimed at aligning capacity with demand and optimizing routes to improve productivity and reduce costs.
In addition to changes in its air network, FedEx is also taking steps to enhance ground efficiency. This includes reducing routes, hours, vehicle rentals, and other on-road expenses. For example, in Europe, FedEx has optimized its ground network routes to improve productivity, resulting in a reduction of approximately 11% of routes in the UK and 12% in Germany. However, due to the vast and complex nature of the Express network, the cost base is expected to remain constrained in the short term as the company adjusts to changing demand conditions. Nevertheless, FedEx has already announced measures such as reduced flight hours by 8% and salary and benefit expenses by 4% in recent quarters to address the challenges posed by fixed expenses while mitigating the impact of revenue declines.
In the U.S. domestic Express segment, FedEx has made significant changes by implementing a single daily dispatch of couriers, removing domestic pickup and delivery routes, and improving hub and ramp efficiency. These changes are expected to achieve approximately $50 million in savings in the fiscal fourth quarter, with the potential for savings to ramp up to about $300 million by fiscal 2024. These measures reflect FedEx's commitment to continuously optimize its operations and deliver cost savings while maintaining service standards.
Another area where FedEx is driving cost savings is in its Ground division. The company expects savings in Ground to be $350 million to $500 million in FY 2023. These measures include canceling several planned ground network capacity projects and managing staffing levels and associated expenses effectively. As a result, despite volume pressures, FedEx Ground has continued to deliver for its customers during peak periods, with an average time in transit of approximately 2 days compared to 2.35 days in the fiscal year 2022. These efforts have contributed to an increase in cost per package of 8% despite 11% volume declines, while total operating expenses were down $345 million year-over-year, and total operating income was up 32% year-over-year in the fiscal third quarter. These results demonstrate how the company has found some middle ground between reducing costs and meeting service standards.
Exhibit 1: Monthly volume trends
In addition to operational changes, FedEx is taking steps to right-size its overall cost structure by addressing overhead expenses. This includes plans to close nearly 140 FedEx Office locations and at least 5 corporate office facilities, which are expected to contribute $350 million to $500 million in cost savings. The FedEx Services segment has halted all non-critical projects to further optimize costs. The company is aggressively managing headcount, including attrition, and expects the U.S. headcount to be down roughly 25,000 year-over-year by the end of FY 2023. These measures are aimed at aligning teams with the network changes underway to ensure a leaner and more efficient cost structure for sustained profitability.
The cost-saving measures implemented by FedEx in FY 2023 are expected to generate significant savings of $2.2 billion to $2.7 billion, with approximately $1 billion of the savings being permanent. These actions are crucial in mitigating the impact of the economic challenges and service-related issues that the company faced in Asia, Europe, and the U.S., and are aimed at positioning FedEx for a strong recovery in FY 2024. The company, similar to how airlines emerged as leaner businesses from the pandemic disruption in 2020, is likely to emerge as a much more flexible business that is less susceptible to the business cycle effect.
The Outlook for E-Commerce and its Influence on Delivery Services
The e-commerce industry has a direct impact on delivery companies such as FedEx, as the two industries are closely intertwined. The continued growth of e-commerce has significantly changed the landscape of the logistics and delivery industry, with increased demand for fast, reliable, and efficient shipping services.
The e-commerce industry has been experiencing explosive growth through 2021, and the slowdown in 2022 is likely to be a blip in the growth story. According to Statista, online retail sales will reach $6.51 trillion this year and are expected to reach $9.4 trillion by 2026. This rapid expansion of e-commerce has created new opportunities and challenges for delivery services.
Exhibit 2: Global in-store and e-commerce retail sales (2022 and 2026)
On the positive side, the growth of e-commerce has resulted in increased shipping volumes for FedEx, as more consumers turn to online shopping for their needs. This has created a larger customer base for the company and increased demand for its services. FedEx has been investing in its e-commerce capabilities and expanding its network to meet this growing demand. The company has also been focusing on providing specialized services for e-commerce businesses, such as FedEx Fulfillment, which offers warehousing, packaging, and shipping solutions for online merchants.
However, the e-commerce boom has also posed challenges for delivery service providers. The rising consumer expectations for fast and convenient deliveries have put pressure on logistics networks and increased the complexity of last-mile deliveries. E-commerce businesses require seamless integration with logistics providers, real-time tracking, and flexibility in delivery options. These requirements have forced FedEx to continually invest in technology, infrastructure, and operational efficiency to meet evolving demands.
Moreover, the intense competition in the e-commerce market has also impacted pricing dynamics in the delivery industry. E-commerce businesses are constantly seeking cost-effective shipping solutions, which has led to increased price competition among delivery service providers. This has put pressure on FedEx to optimize its cost structure, streamline operations, and find innovative ways to reduce costs while maintaining service excellence.
In hindsight, I believe these challenges have been a net positive for FedEx shareholders as the company has made several positive changes to its business to overcome these challenges. With the e-commerce industry expected to grow in leaps and bounds through 2030, I believe FedEx is well-positioned to thrive on the back of more streamlined business operations.
Positive Earnings Revisions: A Catalyst Driving Stock Prices Higher
At Leads From Gurus, we use earnings revisions, earnings surprises, and the historical sensitivity of stock prices to predict long-term stock prices. A quick look at the earnings estimates revision history for FedEx reveals the recent strength in FDX stock has been backed by convincingly positive estimates. In the last 3 months, Fiscal 2023 EPS estimates have been revised positively 27 times with no negative revisions.
I believe Wall Street is reacting positively to the recent strategic initiatives introduced by the company as FedEx is now beginning to focus more on profitability, leaning away from its prior strategy of gaining market share at any cost. With the competition in the last-mile delivery sector reaching new highs in the last 5 years, FedEx resorted to offering attractive prices to lure customers, a strategy that worked well to expand its business and to compete with United Parcel Service, Inc. ( UPS ) which entered the e-commerce boom on stronger footing compared to FedEx. Today, FedEx is taking a step back to focus more on earnings, and this approach is likely to fetch more positive earnings revisions for the next fiscal year (2024). The fiscal 2024 consensus EPS estimate has come down from more than $25 a year ago to $18.28 today, even after benefiting from recent positive revisions. Negative earnings revisions in 2022, in my opinion, have created a platform for better-than-expected earnings next fiscal year as the company has made encouraging changes focused on profitability. This realization, in return, will force analysts to continue hiking their EPS estimates in the coming months. This could turn out to be a catalyst driving FDX stock higher from here.
Takeaway
In the last 5 years, FedEx Corporation has become a better competitor to UPS, and I believe the positive momentum will continue from both a financial performance perspective and a market performance perspective. The expected impact of a recession was priced in 2022, which leaves room for FedEx to exceed expectations in the next fiscal year aided by the successful execution of recently implemented business transformation strategies.
In an ideal world, I would prefer to invest in FedEx Corporation stock at a price below or at least around $150. In the next few days, I am planning to finalize my cash flow-based valuation model for FedEx to determine whether there is a sufficient margin of safety today to initiate a new long position at these prices. If I had invested in FedEx Corporation around $150 when I had the chance a few months ago, I would not be booking my profits just yet.
For further details see:
FedEx Stock: The Momentum Is Likely To Continue