Valuentum Exclusive Analysis for the Discerning Investor

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Image Source: FedEx Corporation – Second Quarter of Fiscal 2022 Earnings Infographic

By Callum Turcan

On December 16, the logistics giant FedEx Corporation (FDX) reported second quarter earnings for fiscal 2022 (period ended November 30, 2021) that beat both consensus top- and bottom-line estimates. The firm also moderately raised its earnings guidance for fiscal 2022 in conjunction with its earnings update after previously reducing its full fiscal year guidance when reporting its fiscal first quarter earnings update.

FedEx noted in its fiscal second quarter earnings press release that “higher revenue per shipment at all transportation segments” positively benefited its operating income performance and helped offset headwinds from labor shortages and related supply chain constraints. The company also recently announced a new $5.0 billion share buyback program that includes a $1.5 billion accelerated share repurchase program component.

Earnings Update

FedEx’s GAAP revenues reached $23.5 billion last fiscal quarter, up 14% year-over-year, aided by past pricing increases. In September 2020, FedEx drove mid-single-digit pricing increases across virtually all of its shipping offerings (FedEx Express, FedEx Ground, FedEx Freight) that went into effect in January 2021. FedEx has done a stellar job pushing through pricing increases to offset rising costs. In September 2021, FedEx announced another round of pricing increases that will be effective starting in January 2022. These latest pricing increases are slightly more robust than the previous round.

The proliferation of e-commerce activities accelerated during the coronavirus (‘COVID-19’) pandemic, helping to drive up demand for last-mile distribution services. FedEx has made meaningful investments in automation (such as robotic package sorting “arms” at its major fulfillment center in Memphis, Tennessee) and has embarked on major additions to its warehouse and distribution operations in recent years to keep up.

Since the start of the COVID-19 pandemic, labor shortages have hampered FedEx’s ability to meet robust demand for its logistical services. However, it appears that FedEx has been able to improve its situation on this front in recent months. Within FedEx’s latest earnings press release, its management team noted that:

“Strategic investments that we have made to our networks and systems have enabled us to provide critical delivery capacity and supply chain expertise to support the needs of our customers, while also making it possible for us to capitalize on the growing e-commerce parcel market.” --- Raj Subramaniam, President and COO of FedEx

Additionally, during FedEx’s latest earnings call, management noted (emphasis added, moderately edited):

“We continued to take bold actions in [the fiscal second quarter] to hire and invest in our frontline team members and thus increase network efficiency. These actions [included] pay premiums, increased paid time off and tuition reimbursement. I am pleased to share that we have made considerable traction in recruiting frontline positions. Last week, we exceeded 111,000 applications, the highest level in FedEx history. To put this in perspective, we had 52,000 applications the week of May 8. This has led to appropriate staffing levels…” --- President and COO of FedEx

However, there are some downsides to be aware of, as FedEx’s cost structure is on the rise. Management also noted in FedEx’s latest earnings press release that “the challenging labor market affected the availability and cost of labor resulting in network inefficiencies, higher purchased transportation costs, and higher wage rates, which increased costs by an estimated $470 million year over year, primarily at FedEx Ground” which is why pricing increases are so important.

Last fiscal quarter, FedEx’s GAAP operating income rose 9% year-over-year, hitting $1.6 billion. Its GAAP operating margin dropped by a little over 30 basis points during this period due to the aforementioned headwinds offsetting recent pricing increases and productivity improvements from past automation investments.

Even on an adjusted non-GAAP basis, FedEx’s operating margin dropped last fiscal quarter on a year-over-year basis. During the second quarter of fiscal 2022, FedEx reported $1.7 billion in adjusted operating income and an adjusted operating margin of 7.1%, versus $1.5 billion in adjusted operating income and an adjusted operating margin of 7.4% in the second quarter of fiscal 2021 (period ended November 30, 2020).

As an aside, FedEx acquired TNT Express (offers logistical services in Europe) through a EUR€4.4 billion deal back in May 2016, though FedEx is still incurring meaningful integration expenses. This is one of the reasons FedEx provides adjusted financial metrics.

Cash Flow, Capital Allocation, and Balance Sheet Considerations

FedEx generated $0.9 billion in free cash flow during the first half of fiscal 2022, while spending $0.4 billion covering its dividend obligations and another $0.7 billion buying back its stock during this period. As noted previously, FedEx recently launched a new $5.0 billion share buyback program with an accelerated share repurchase program component. Its new buyback program is in addition to the program announced in January 2016 that allowed for up to 25 million in shares to be bought back (which had 2.3 million in remaining share buyback authority according to FedEx’s earnings press release).

Our fair value estimate for FedEx sits at $295 per share indicating that its share buybacks, in moderation, are a good use of capital in the current environment given that shares of FDX are trading at a steep discount to their intrinsic value as of this writing. However, the company exited November 2021 with a net debt load of $13.7 billion (inclusive of short-term debt). While it did have $6.8 billion in cash and cash equivalents on hand at the end of this period, FedEx’s financial flexibility is still somewhat limited.

FedEx is investing heavily in its business to meet robust demand for its offerings while staying ahead of the competition such as Amazon Inc (AMZN) and United Parcel Service Inc (UPS). These investments are pressuring its abilities to generate huge free cash flows (even though they have improved of late). Put another way, FedEx operates in a capital-intensive industry and its capital investments in any given period will likely be quite substantial. FedEx’s management team needs to be cognizant that share repurchases, while a good use of capital, need to be limited in nature or else the firm will run the risk of becoming overly leveraged.

Outlook

The company moderately revised its fiscal 2022 guidance during its latest earnings update. FedEx left its full fiscal year capital expenditure guidance the same at $7.2 billion, though it now expects its adjusted diluted EPS to come in at $20.50-$21.50 in fiscal 2022 (up from $19.75-$21.00 previously) which does not include any integration expenses relating to its TNT Express and excludes other expenses as well (such as mark-to-market accounting activities relating to its retirement plans and various business restructuring activities, among other things).

For reference, FedEx reported $18.17 in adjusted diluted EPS and spent $5.9 billion on its capital expenditures in fiscal 2021 (period ended May 31, 2021). FedEx expects its financial performance will improve considerably in fiscal 2022 versus fiscal 2021 levels, though its capital expenditure expectations are also on the rise.

Concluding Thoughts

Shares of FDX moved higher in the wake of FedEx’s latest earnings report and are steadily converging towards our fair value estimate as of this writing. We do not include FedEx as an idea in any of the newsletter portfolios. The company is a leader in its field, but we see better opportunities out there. Shares of FDX yield ~1.2% as of this writing.

FedEx's 16-page Stock Report (pdf) >>

FedEx's Dividend Report (pdf) >>

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Callum Turcan does not own shares in any of the securities mentioned above. Honeywell International Inc (HON), Lockheed Martin Corporation (LMT) and Republic Services Inc (RSG) are all included in Valuentum’s simulated Dividend Growth Newsletter portfolio. Republic Services Inc is included in Valuentum’s simulated ESG Newsletter portfolio. Some of the other companies written about in this article may be included in Valuentum's simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.