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Investment Thesis
Last time I talked about FedEx Corp (NYSE:FDX), I wrote about how the company’s management style was a major red flag and why its cost-saving initiatives are not going to be good enough. Since then, while the company has indeed made progress with respect to cost savings, it continues to remain under pressure due to the current macro environment.
In this article, I argue why initiatives such as One FedEx and the presence of an activist hedge fund are not enough to offset the pressure that the company continues to experience in its volumes and margins. Moreover, from a valuation perspective, the stock, based on my analysis, is currently overvalued.
Fourth Quarter Highlights
The company closed out a challenging year with a decent performance in Q4. While revenues of $21.93 billion came in below estimates by $734.1 million, non-GAAP EPS of $4.94 beat estimates by $0.07. The strong EPS figure was despite the company having to endure an overall decline in global volumes, an impressive feat, in my opinion.
For the full fiscal year, the company generated revenues of $90.2 billion, down 3.5% year-over-year, and non-GAAP diluted EPS of $14.96, down a little over 27% year-over-year. Management offered an outlook, which was subdued in my opinion, and they attributed it to the current environment that remains engulfed in macroeconomic uncertainty. More specifically, FY24 revenues are expected to come in flat to up low-single-digits, and diluted EPS is expected to come in between $16.50 and $18.50. The EPS guidance excludes the MTM retirement plans accounting adjustments, which, given the uncertainty surrounding interest rates and the financial markets, management argued that they could not be predicted. Management also anticipates cost savings of approximately $1.8 billion for FY24 as part of its DRIVE initiative.
Cost-Saving Initiatives Unlikely to Offset Pressure on Margins
The company, in my opinion, is indeed making progress with its cost-saving initiatives. In Q4, for instance, the company managed to deliver a $2 billion year-over-year reduction in operating costs. However, I do not think that these cost savings are going to offset the significant declines in volumes experienced across all the company’s segments. To offer some context, FedEx Ground saw volumes decline 6% in Q4, the Express vertical saw volumes decline 7%, and the Freight vertical experienced a decline to the tune of 18%. The company also announced that it was permanently retiring 18 aircraft at its Freight vertical as it continues to struggle from significant margin pressures.
Furthermore, given the macro headwinds that are likely to exist for the foreseeable future, both the volumes and margins are likely to remain under pressure. According to ING, global trade growth is likely to remain under pressure at least until 2024 due to “geopolitical concerns, protectionism, and supply chain considerations.” Furthermore, global trade is also projected to lag the GDP growth, according to the same report. As a result, I do anticipate FDX’s volumes and margins to remain under pressure for the foreseeable future.
Given this backdrop, I also do not think that the projected $1.8 billion in cost savings as part of DRIVE will be enough to offset the volume declines. Moreover, management did not offer any clear plans of where these savings were going to come from. In his prepared remarks, all CEO Raj Subramaniam said was “Given our progress, we are confident that we can deliver on our previous goal for about $1.8 billion in cost reduction benefits from DRIVE this fiscal year and $4 billion of permanent cost reductions in the fiscal year 2025.” The source of these cost savings was not clearly articulated. While outgoing CFO Mike Lenz did mention that the least amount of savings will be in Q1 of FY24 before gradually increasing in the subsequent quarters, there was no clear roadmap for how and from where these cost savings are going to materialize.
“One FedEx” Initiative in Canada Doesn’t Tell the Full Story
One of the key takeaways from FDX’s Q4 performance was the progress made through the “One FedEx” initiative. The initiative, through which, the company plans to ultimately bring the Express, Ground, Services, and other verticals into a single company, is expected to start next year. During the Q4 earnings call, the company announced that it’s set to transition all FedEx Ground operations and personnel in Canada to FedEx Express from April 2024. This move, according to management, should generate annualized savings of $100 million once completed in FY25.
While this is a positive, I wonder how the company is going to undertake the “One FedEx” program in the U.S. where every market is different. While the process has already started in certain U.S. markets such as Alaska, Hawaii, and Minneapolis, the company has adopted a hybrid model in these places, whereby the company will have couriers in some markets and contractors in others. This appears to be chaotic rather than streamlined, in my opinion.
Furthermore, management did admit that the initiative in the U.S. is going to take significant time to complete in markets such as the U.S., so the projected overall benefit of $2 billion in annual cost savings via this initiative is unlikely to bear fruit anytime soon.
Activist Presence is Not a Needle Mover
In my opinion, there are two key reasons why FDX stock has had a great run despite deteriorating fundamentals. First, the company continues to pay a healthy dividend, although its 2% dividend yield currently lags behind its peer UPS, which stands at 3.7% according to Refinitiv. In addition, the company repurchased $1.5 billion worth of stock in FY23 and has plans to repurchase a further $2 billion worth of stock in FY24. So, the company has been generously returning cash to shareholders.
Second, the company has an activist hedge fund, D.E. Shaw, as one of its influential shareholders despite having a stake of less than 1%. The hedge fund was behind the dividend boost and also managed to install two of its directors on the company’s board last year. The activist directors though, in my opinion, are not likely to move the needle. The hedge fund’s choice of directors, Amy Lane and Jim Vena is strange. While Mr. Vena does have 40 years of railroad experience and was also the COO of Union Pacific and therefore, should have useful advice for the board, Ms. Lane does not have any experience in the logistics space. She was the head of the global retailing investment banking group at Merrill Lynch before her retirement in 2002 and is currently on the board of TJX Cos., an apparel company, and NextEra Energy, a utility player. Neither of these directors is a convincing pick when it comes to bringing about serious change within FDX, especially from a cost-saving perspective.
While two directors alone can’t turn around an entire company and while Mr. Vena should certainly make a significant contribution based on his prior experience, I do not think the activist’s presence and its moves so far warrant a 43% jump, YTD, in the stock price.
Valuation
|
Forward Price/EPS Multiple Approach |
|
|
Forward P/E Multiple (Industry Median) |
14x |
|
Projected FY24 Diluted EPS |
$15.58 |
|
Price Target |
$218 |
Source: Refinitiv, Author’s Calculations & FDX Q4FY23 Earnings Call
The company, as I mentioned earlier, now sees adjusted FY24 EPS come in between $16.50 and $18.50. However, this guidance doesn’t account for MTM retirement plans accounting adjustments. I have assumed the same figure as last year for the accounting adjustments, which is $1.92. This puts the EPS in the range between $14.58 and $16.58. I have assumed the midpoint of this guidance, i.e., $15.58.
The company currently trades at a forward P/E of 14x, which, according to Refinitiv, is in line with the company’s 10-year historical median value. I have assumed this as the company’s forward P/E for my calculations.
At a forward P/E of 14x and an EPS of $15.58, we get a price target of $218, which is nearly 13% lower than current levels, placing the stock in overvalued territory.
Risk Factors
The healthy dividend and the company’s plans to repurchase stock to the tune of $2 billion are positive catalysts for the company.
Then there’s the potential for a rebound in e-commerce, which is a factor that management was keen to point out. According to the U.S. Department of Commerce, e-commerce sales jumped 8% year-over-year in the first quarter of 2023. If this growth remains sustainable, then FDX margins should receive a timely boost.
Finally, there’s the resilience seen in the U.S. economy even as the Fed’s battle against inflation rages on. The first quarter GDP of the U.S. economy came in at 2%, much stronger than the estimated figure of 1.3%. If the U.S. does manage to avoid a recession and a shock in the labor markets is avoided, it could be an additional tailwind for FDX.
Concluding Thoughts
From a fundamental perspective, I continue to remain unimpressed by FDX. The cost-saving initiatives are promising, but given that the company continues to operate in an environment where both volumes and margins are likely to remain under pressure, these initiatives might not be a strong offsetting factor.
The “One FedEx” initiative, which has started to take shape, especially in Canada, should face considerable challenges going forward, especially in the U.S. What the company is expected to achieve in Canada is not a fair reflection of the overall program as the Canadian and the U.S. markets are not the same.
The presence of an activist hedge fund doesn’t move the needle either, especially since D.E. Shaw has less than a 1% stake in the company and its choice of directors is hardly encouraging. Finally, there’s the valuation, which indicates that the company is overvalued at current levels.
I have been wrong about this company in the past. However, from a fundamental perspective, I still can’t come to terms with the company and its stock price at current levels.
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