NEW YORK (September 23) – Federal Express (NYSE: FDX) reported earnings and announced a cost-cutting program ahead of schedule today, about an hour after its share price hit a 52-week low. The release sent the stock price higher high of the day at $156.70 before stabilizing to close at $154.54. The stock was essentially flat in after-hours trading.
Why FedEx is in trouble
FedEx warned last week that it was suffering from what it described as “macroeconomic trends” that were affecting “global volumes…both internationally and in the United States,” but warned that conditions had changed rapidly in the last weeks of the quarter. As we said last week, FedEx depends on the health and wealth of the economy as a whole and neither is particularly good at this point. Europe is set to enter recession and is probably already there. Deutsche Bank said earlier this week that it expects a deeper recession in the eurozone following Russia’s shutdown of Nord Stream 1 gas supplies. He estimates that GDP will fall by 2.2% in 2023, with German GDP possibly falling by 4%. The recession in the euro zone is expected to have repercussions in Asia, its main trading partner.
Response from FedEx
Cost savings Having no control over the macro environment in which it operates, FedEx CEO Raj Subramaniam said the company “will focus on issues that we can control, primarily on the cost side.”
FedEx is reporting on a fiscal year from June 1, 2022 to May 31, 2023 and the savings discussed in yesterday’s earnings call are for fiscal year 23. Overall, the company says the savings will generate 2, $5 billion to $2.7 billion, of which approximately $1 billion will be permanent. These plans include:
- a reduction in global flight hours, to include 11% of daily transpacific frequencies, 9% of daily transatlantic frequencies and 17% of daily frequencies on the route between Asia and Europe.
- improve FedEx Express ground efficiency, reduce routes, hours, vehicle rentals and other on-road expenses, such as 11% of routes in the UK and 12% in Germany.
- At FedEx Ground, some Sunday operations will be reduced at 170 locations.
- At the corporate level, there are plans to close nearly 140 FedEx offices and at least 5 corporate offices.
The company expects savings in each of the segments
- Express: $1.5 to $1.7 billion this fiscal year
- Land: $350 million to $500 million
- Corporate: $350 million to $500 million
The company said it realized $300 million in savings from these efforts in the first quarter and expects about an additional $700 million in the second quarter, with the remainder of the FY23 savings to be realized over the course of the second half of the exercise.
These expected savings are in addition to savings from the FedEx DRIVE program, discussed in more detail during the FedEx investor presentation on June 28. This program is expected to generate some $4 billion in cost savings by the end of the fiscal year on June 30, 2025.
FedEx raises rates 6.9% in January. Also introduced is a new remote area surcharge and peak US residential pricing. In Europe and Asia, FedEx will also launch a new handling surcharge in January. In August, FedEx implemented adjustments to the international fuel surcharge table for Asia, Europe, the Middle East and Africa.
Why FedEx Plans Won’t Work
The company expects the second quarter to generate revenue of $23.5 billion to $24 billion. We think the outlook is likely optimistic, as are the longer-term hopes for the following reasons:
- The cost savings will likely be insufficient. Anyone who’s been through a cost-cutting cycle knows how disruptive it can be to the whole business, and that “reality” often doesn’t meet expectations. FedEx’s plans, including DRIVE, but especially the cuts discussed yesterday, appear to be more reactive than strategic, as, say, a zero-based budgeting program would achieve. Moreover, as reported early this morning here on SA, and as Deutsche Bank analyst Amit Mehrotra raised on yesterday’s call, these cost savings are likely to evaporate in an inflationary environment. .
- Management underestimates macro risks. We expect the volume declines to be steeper and longer-term, so FedEx will experience more demand destruction than expected. The central tendencies of the Federal Reserve dot plots released earlier this week support this view, as well as the projected decline in the Eurozone discussed above. We also note that the Russian-Ukrainian war continues to escalate as President Zelensky appears to be shifting Ukraine’s agenda from defending Ukraine to punishing Russia for its aggression in a “peace agenda”.
- FedEx premium prices will evaporate. ShipMatrix reported that “the parcel industry dominated by FedEx, UPS, USPS and Amazon will face huge excess capacity during the peak (i.e. holiday) season of 2022, FedEx’s second quarter. Plus, even SMBs have access to ShipMatrix to optimize their shipping FedEx has raised prices 6.9% before, for example in 2008 and 2012. But this “go to” rate hike, along with the other surcharges, ignore what will likely be a buyer’s market for FedEx services.
- Shippers from local countries will add additional margin pressure on FedEx’s premium pricing. FedEx faces margin pressure not only from UPS, but also from overseas-based companies like Yamato Transport (Japan), DSV/AS (Denmark), Deutsch Post AG (Germany), etc. , many of which have locations or agents in the United States. These overseas-based shippers need not compete on price with a company whose financial statements are expressed in “King Dollar”, currently the strongest currency in the G7. This currency-based competition will likely worsen if, as some expect, China devalues the yuan after the CCP congress in October. (Commentator SA pg99, who says he lives in Thailand, reports that goods he previously received from Amazon (AMZN) via FedEx now go through Shunfeng, Shenzhen, China.)
- Cost reductions will likely lead to service issues. According to Logistics Management, FedEx’s on-time performance in the 50th calendar week of 2021 was up to ten percentage points behind its competitors, United Parcel Service (UPS) and the US Postal Service. Cutting costs, while obviously necessary, can only disrupt customer service and risk customer satisfaction. These problems are getting worse significantly on the revenue side if UPS is the first to reinstate its “money back guarantee” that FedEx and UPS scrapped during the pandemic.
FedEx’s response to lower volumes and macroeconomic effects is to raise prices and surcharges and cut expenses, in the words of management, “control the things we can.”
But these efforts will likely be disappointing. Between demand destruction and mounting competitive pressures, and service disruptions caused by FedEx’s drastic cost reductions, we expect declining brand value and disappointing earnings for at least the next 6 quarters. We estimate the stock to drop from $120 to $130 by fall 2023.
Note: Our reviews tend to be event driven most of the time. They are primarily written from a public policy, economic or political/geopolitical perspective. Some are written from a management consulting perspective for companies we believe are underperforming and include strategies we would recommend if the companies were our clients. Others discuss new management strategies that we believe will fail. This approach lends particular value to contrarian investors to uncover potential opportunities in companies that would otherwise be in recession. (The opinions regarding these companies here, however, assume that the company will not change).