Image Source: FedEx Corporation – 2019 Annual Stockholders Meeting September 2019 IR Presentation
By Callum Turcan
In the days leading up to FedEx Corp (FDX) latest earnings report where the firm missed by a mile (we’ll cover that in a moment, but first, let’s look how we got here), news broke that Amazon (AMZN) is now blocking third-party sellers that use its marketplace platform from using the FedEx Ground delivery service (which handles North American volumes) to ship to Prime customers. This comes on the heels of FedEx and Amazon ending two significant shipping contracts earlier this year, including the arrangement where FedEx Ground would handle some of Amazon’s packages, a deal that expired at the end of August. Please note that FedEx Ground is a small-package delivery service that caters to America and Canada, and that other FedEx options for certain packages bought through or sold by Amazon are still available.
Going Separate Ways
Until recently, (Amazon made this decision public on Monday December 16, and it reportedly went into effect the day prior), third-party sellers have still been using FedEx’s ground delivery service to complete some package deliveries to Prime customers. Now Prime orders can’t use FedEx Ground, ostensibly until service improves but there is likely more to the story than that (meaning Amazon doesn’t want to do business with FedEx as FedEx doesn’t want to do business with Amazon). Third-party merchants make up well over half of all merchandise sold on Amazon.
Amazon didn’t represent a huge portion of FedEx’s revenues, and FedEx didn’t handle that much of Amazon’s package volume before the break-up, and we expect both companies will be able to make it on their own. However, there are significant short-term considerations. FedEx is a company with high operating leverage, and losing even a small part of its revenue base can have a large impact on its financial performance. For Amazon, the company is betting big that its own delivery network and other third-party partners, like United Parcel Services (UPS), can pick up the slack. Please note the contract FedEx Express had with Amazon was also allowed to expire this year.
Particularly in the US but eventually the entire world, Amazon seeks to build out its own shipping and logistics operation that will be able to handle both internal and third-party volumes in massive quantities. This creates an entirely new way for Amazon to generate free cash flows over time.
For FedEx, the shipping and logistics company wants to work closer with retailers (ex-Amazon) that are seeking to grow their e-commerce presence such as Target Corporation (TGT) and Walmart Inc (WMT). Please note that these are two companies that aren’t actively working to create their own competing logistics and shipping company, at least not to the scale of Amazon’s ambitions. On a similar note, many retailers don’t want to work with the cloud-computing wing of Amazon, Amazon Web Services (‘AWS’), so as to not feed the profit generating machine that powers their arguably biggest threat.
Earnings Overview
On December 17, FedEx reported second-quarter earnings for its fiscal 2020 (period ended November 30, 2019). The company missed by a mile on both the top- and bottom-line, and lowered its adjusted non-GAAP EPS forecast for the full fiscal year down to $10.25-$11.50 from $11.00-$13.00 previously. Weaker global economic activity, the loss of a lot of its Amazon business, rising FedEx Ground costs, and a competitive pricing environment hurt FedEx’s financial performance substantially. Shares of FDX were down sharply in after-hours trading on December 17. We’ve written numerous articles in the past (link here) highlighting why we don’t include FedEx in our newsletter portfolios.
FedEx’s GAAP revenues dropped by 3% year-over-year in the second quarter, while its GAAP operating margin tanked by roughly 335 basis points, which saw its GAAP operating income more than cut in half. GAAP diluted EPS dropped by 39% year-over-year. It was a brutal quarter.
At the end of November 2019, FedEx had $2.0 billion in cash and cash equivalents on hand versus $0.2 billion in short-term debt and $18.7 billion in long-term debt. That hefty net debt load weighs negatively on its dividend coverage. Due to sharp increases in its capital expenditures, FedEx generated negative free cash flows during the first half of its fiscal 2020. For reference, FedEx generated just $0.1 billion in free cash flow on $5.6 billion in net operating cash flow in fiscal 2019. In May 2019, FedEx announced FedEx Ground would run seven days a week year-around starting in January 2020 (instead of just during the peak holiday sales season), providing greater shipping options to the majority of the US population. Expanding its “last-mile” deliver offering further will require meaningful capital investments and substantial incremental operating expenses, but this move does expand FedEx’s revenue generation capabilities significantly as well.
FedEx intends on raising rates on its FedEx Express, FedEx Ground, and FedEx Home Delivery shipping rates on January 6, 2020 by mid-single-digits on an annual basis. While that should support its financials going forward to a degree, the trajectory of the global economy, and most importantly trade/goods flows, remains paramount to FedEx’s financial performance.
Concluding Thoughts
The low end of our fair value estimate range of FedEx sits at $157 per share. FedEx’s Dividend Cushion ratio sits at -0.6x (negative 0.6x), earning the firm a POOR Dividend Safety rating and playing a key role in why we view the company’s dividend growth trajectory as weak. While FedEx generates a lot of net operating cash flow, the firm’s business model is capital-intensive, especially as it invests heavily in growing its ground and last-mile delivery game. Additionally, FedEx’s net debt load further weighs on its dividend coverage. Shares of FDX yield ~1.6% as of this writing.
We are still staying away from FedEx as its ability to generate free cash flows remains pressured by its need to invest heavily in the business to keep up with the likes of Amazon and others. FedEx’s dividend payout could be at risk should exogenous shocks (i.e. a breakdown in the partial US-China trade war truce) continue weakening its financial performance.
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Callum Turcan does not own shares in any of the securities mentioned above. Some of the companies written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.