Millions of FedEx Corp. stakeholders are still digesting the Thursday night’s calamitous announcement of a massive quarterly income shortfall at its largest unit and the withdrawal of financial guidance for the rest of its fiscal year a bit more than a quarter of the way through it.
The question is whether the news signals a larger problem of weakening demand in the U.S. and abroad or a more focused case of bad execution by one company.
No one disputes that the international macro environment has taken a turn for the worse. It is also indisputable that FedEx (NYSE: FDX), with its huge exposure to Asian airfreight lanes, would take a disproportionately hard hit if demand in the region were to deteriorate. In the announcement, executives pinned much of the blame on weakness in trans-Pacific air volumes that accelerated toward the end of its fiscal 2023 first quarter and came too late for the company to take corrective measures. FedEx’s fiscal year begins on June 1.
However, the numbers published Thursday hint at something more systemic and company specific.
The current problems center on FedEx Express, the company’s air and international unit and the largest of its three units. The unit posted a $572 million year-on-year decline in operating income, even though revenues were slightly higher during the same period. The waterfall drop contributed heavily to a sharp drop in the parent’s adjusted earnings per share to $3.44 from a consensus of around $5.14. (FedEx Ground and LTL unit FedEx Freight posted revised year-over-year gains in operating income. FedEx Ground’s improvement was modest while FedEx Freight’s results were stellar.)
FedEx said the Express unit experienced a $500 million quarterly revenue shortfall compared with the company’s earlier forecasts. However, analysts said there was no way that should have equated to a near dollar-for-dollar reduction in operating income unless the unit didn’t have its cost house in order.
The revised results imply a “concerning inability to respond with cost mitigation, which we believe is more indicative of operating execution than market forces,” said Amit Mehrotra, analyst at Deutsche Bank, in a Thursday note.
Mehrotra said the results, relative to the expectations that the company set for Wall Street as recently as late June, are the weakest set of numbers he’s seen in 20 years of securities analysis. While most analysts planned for the possibility that the company might miss consensus estimates due in part to slowing demand, no one was prepared for the magnitude of Thursday’s news. Certainly not Wall Street, which sent FedEx shares down more than 21%, or more than $43 a share, near the close of trading on Friday.
Adding to the angst is that FedEx’s preannouncement came just a week before it officially publishes the quarterly results and just five days before its annual shareholders meeting Monday at its Memphis, Tennessee, home base.
Deeper cuts needed
Satish Jindel, founder and CEO of consultancy ShipMatrix, who has worked with FedEx in various capacities for 25 years, said the company needs to cut much deeper than the cost-savings initiatives it announced on Thursday. Those cost actions amount to “putting a Band-Aid on the situation when it needs surgery,” Jindel said in an email. “It’s not enough and it will take a long time.”
FedEx Ground, the company’s ground delivery unit, needs to completely eliminate its costly Sunday delivery program rather than merely reduce Sunday operations, Jindel said, adding that deeper staffing cuts also need to be made at the corporate level.
FedEx’s capex budget also needs to be reduced by more than by the planned $500 million the company announced on Thursday, Jindel said, noting that for one thing, the company won’t need to spend heavily to ramp up for this year’s peak deliveries season. Demand is likely to be flat compared with last year as consumers continue to return to in-store shopping and high inflation reduces discretionary purchasing power.
What’s more, the U.S. Postal Service announced on Monday a network expansion that will allow it to handle 60 million parcels a day during the 2022 peak, up from 53 million in 2021.
Given the trends, FedEx and rival UPS Inc. (NYSE: UPS) could find themselves saddled with higher costs and unused capacity unless they rationalize their networks before peak season cranks up in late November, Jindel said.
In general, FedEx puts too much emphasis on revenue growth — which is out of any carrier’s control — and not enough attention on the cost savings it can achieve, Jindel said. By contrast, UPS under CEO Carol B. Tomé has been aggressively cutting costs for more than two years.
That, among other things, explains why UPS’ operating margins are superior to FedEx’s despite UPS bearing higher costs because of its unionized workforce. UPS, which releases its third-quarter results next month, affirmed its quarterly guidance during an early September analysts’ meeting. UPS said that the international macro environment was difficult, according to analysts in attendance.
The closest FedEx came to addressing execution problems in its announcement was to admit it had suffered “service challenges” in Europe during the quarter. Though it didn’t specify what those challenges were, it is apparent that FedEx continues to struggle completing the problematic multiyear European integration of TNT Express, the Dutch delivery firm that FedEx acquired in 2016.
FedEx has spent more than a few quarters assuring analysts that the integration was finally done, and even went so far as to disclose specific timelines for its completion. Thursday’s disclosure casts a shadow over that progress and reinforces the perception that the company has a penchant for overpromising and under-delivering.
Dean Maciuba, who spent 35 years at FedEx in various executive roles and is now managing partner for the U.S. at Crossroads Parcel Consulting, said in a LinkedIn post Friday that FedEx suffers from excessive corporate hubris. Top executives have stopped listening to customers and to their field salespeople who interact with them, Maciuba said. UPS, with its integrated delivery model in which one driver picks up and delivers every package, is much easier for shippers to work with than FedEx’s siloed model where the three units operate independently.
The power of the FedEx brand is no longer strong enough to obscure the realities of lower operating margins, especially when placed side by side with UPS’ performance, Maciuba said.
Another possible factor, Maciuba said, is the decision by founder and Chairman Frederick W. Smith to step down as CEO, effective June 1. Smith became executive chairman on that date, and few doubt that he remains very involved in the company’s current situation. However, his absence as CEO is “weighing heavily on the company,” Maciuba wrote.
No visibility ahead
That FedEx withdrew its full-year guidance so soon into its fiscal year indicates that it has no visibility beyond the second quarter, which is shaping up to be just as bad, if not worse, than the first. Ravi Shanker, an analyst at Morgan Stanley & Co., said in a Friday note that FedEx’s problems overseas are not the result of exogenous events such as COVID lockdowns in China. Besides, such restrictions have been a tailwind for FedEx as they restricted the availability of competing passenger airline bellyhold capacity, Shanker said.
Rather, Shanker said, the industry is in the initial stages of a post-pandemic parcel delivery “unwind.” FedEx benefited from more than two years of delivery demand spikes and extreme pricing power, Shanker said. Now, a slowing economy and inventory bloat are driving mean reversions in demand and pricing to pre-pandemic levels, he said.
In this environment, cost inflation becomes a major concern because revenue growth isn’t strong enough to offset the higher costs of fuel, labor and equipment, Shanker said. Of particular risk are new contracts between FedEx Ground and its delivery service providers that will contain significant inflationary pass-throughs to the parent, he said. The FedEx unit pays its nonunion contractors on a per-stop or per-mile basis depending on the delivery service being provided.
Spencer Patton, who operated one of the largest FedEx Ground delivery territories until his relationship was terminated by the unit, has repeatedly warned that many contractors are so overburdened with higher operating costs that they will fold by year’s end unless the company raises the rates that it pays them.
It will be hard to find a strand of light in this suddenly dark picture at FedEx. The admittedly imprecise consensus is that the problems are fixable but that it may require a dramatic overhaul of the company’s modus operandi.
In his note, Mehrotra said the only positive takeaway is that “it’s so bad, it’s good,” meaning that the results should make it clear to FedEx executives that bold measures are needed to revive the business.
“This can be a great company,” he wrote. “UPS has shown the world the road map. We remain hopeful that FedEx will embrace the changes needed, as opposed to continuing on the path of incrementalism.”
