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Investment Thesis
FedEx Corp (NYSE:FDX) shocked the markets with its preliminary results and the company’s management then tried to mitigate the damage by announcing a mega cost-saving plan. In this article, I argue why this is a company that is best avoided since the current management has become a major red flag.
Q1 Results: When Management’s Optimism Quickly Evaporated
When FDX announced its Q4 FY22 results, the management commentary was one that was filled with widespread optimism despite the challenging external environment that it was operating in. The optimism was nowhere to be found when the company announced its Q1 results, which was not only bad from a profitability standpoint but also caused the management to spend most of the earnings call trying to appease some very disgruntled analysts by outlining how they are going to mitigate the damage through a gigantic cost-saving plan.
Overall, Q1 Non-GAAP EPS came in at $3.44, beating analyst estimates by $0.64. Revenue came in at $23.2 billion but missed estimates by $580 million. The company now expects Q2 revenues to come in between $23.5 and $24 billion vs. estimates of $23.7 billion and diluted EPS (excluding costs related to business optimization initiatives and business realignment activities) to come in at $2.75, narrowly missing the consensus estimates of $2.80.
The once optimistic FDX management also did not offer any guidance for Q3 and Q4 citing the current macro uncertainties, the very uncertainties that they seemingly ignored last time.
FedEx Corp’s Cost Saving Plan: Why I am not Convinced
FDX now plans to make $2.2 billion to $2.7 billion savings in FY23 by slashing down costs, primarily at its Express vertical. Given that FedEx Express saw its operating income plunge 72% on account of lower volumes and higher expenses, targeting the cost saving initiative at Express was a no brainer.
Management, during the earnings call, also suggested that $1 billion of the overall cost savings are going to be permanent in nature and are not related to the targeted $4 billion savings by FY25. which it announced as part of its “Deliver Today Innovate for Tomorrow” strategy, during the recently concluded Investor Day. Management also provided some additional details about this strategy and talked about how the company plans to reach its $4 billion target by 2025. Unsurprisingly, a chunk of the expense cuts is expected to be at the Express vertical.
The cost-saving plan, while looking promising, is being undertaken by a management who I find hard to trust. This is because, while I appreciate their humility when they mentioned that these results took them by surprise and that they had underestimated the macro conditions, I am shocked that they did not see these challenges coming.
In the previous quarter, CFO Mike Lenz had suggested that the company now expects all their transportation segments’ margins to expand on an adjusted basis thanks to “enhanced revenue quality beyond inflation, technology driven operational efficiency improvements and increasing utilization of our assets.”
Mr. Lenz said this at a time when the percentage of cargo shipments at sea and en-route to the U.S. had declined 30% year-over-year. Furthermore, only 21% of the shipments in the U.S. arrived on time around the period when he said this. Therefore, the future was never looking as rosy as Mr. Lenz predicted, so I question the logic, at the time, behind such a line of thinking.
While this time around he did mention that the business conditions are expected to remain challenging, it is a scenario, which the management should have planned for in the first place. How can I then be convinced that the very same management will carry out its cost-saving plan effectively?
Q1 Performance: Down to Lack of Forward Planning and Not Macro Headwinds
During the earnings call, Chief Customer Office Brie Carere, in response to an analyst question, hinted that although the company made some missteps in Europe, the economy there had gotten worse, and this played a major role in contributing to its troubles. If this was the case, then how did UPS gain market share in the region around the same time?
Furthermore, in response to another analyst question that focused on whether the company has done a product review to look into what has not been working in the last 20 years, CEO Raj Subramaniam reiterated that they have got their issues under control and went to the extent of displaying a tremendous amount of confidence in his team to bail the company out of its current conundrum. Moreover, he blamed every macro headwind possible rather than taking responsibility for the company’s troubles.
Great management takes accountability of its actions, especially during times of trouble. I don’t see that aspect when it comes to the management of FDX.
Valuation
|
Diluted EPS Forecast for FY23 |
||
|
Quarter |
Cash Flows |
Rationale |
|
1 |
$3.44 |
Actual EPS generated |
|
2 |
$2.75 |
Management Forecast |
|
3 |
$4.00 |
A rise in the EPS on account of holiday season. |
|
4 |
$4.00 |
No growth in EPS given the macro headwinds and external challenges. |
Source: Author’s projections
|
Forward Price/Earnings Multiple Approach |
|
|
Forward P/E Multiple (Industry Median) |
10.07x |
|
Projected FY22 Diluted EPS |
$14.20 |
|
Price Target |
$143 |
Source: Refinitiv & Q1FY23 Earnings Call
The company now expects to earn around $2.75 for Q2. That would put the total diluted EPS in the first 6 months to be around $6.20. I assumed that Q3 diluted EPS increases to $4 on account of the holidays and Q4 diluted EPS stays around the same as Q3 EPS, which gives a total FY23 EPS of $14.10.
At current price, this implies that the company is trading at 10.1x FY23 earnings. Given that the industry median forward P/E also stands at 10.1x, and given that this company doesn’t deserve any premium relative to its peers, I have assumed its forward P/E to be 10.1x.
At that multiple, the company should be trading at $143, which is about 5% lower than where it closed on 28th September. Combine this with the little to zero faith I have in the company’s management, I would firmly put this company in the “avoid” category at present.
Concluding Thoughts
I am not a fan of FedEx management. Yes, the company is a blessing for dividend loving investors and for any investors looking to protect their portfolios through dividends, but that’s where the positives end for me. The company’s management is one that doesn’t take accountability of its failures and is attempting to appease the market with mega plans such as multibillion cost-saving initiatives.
I am also not sure whether the management is aware of the magnitude of the macroeconomic challenges that lie ahead. Unless they clean up their mess and start acting more logically, I would be avoiding this stock.
High quality corporate governance is the cornerstone of any successful long-term investment. As far as FedEx goes, at present, I don’t see that.
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