FedEx Asks for Patience Investors Don’t Have
(Bloomberg Opinion) -- FedEx Corp. wants investors to focus on the long term. Investors have questions about how long they have to wait to get there.
The parcel-delivery company reported disappointing fiscal third-quarter earnings after the market close on Tuesday and cut its full-year outlook for the second time in three months. FedEx, which is often regarded as an economic bellwether, set off alarm bells across industries in December when it lowered its guidance and declared that the peak for global growth was behind us. But while sputtering demand in Europe and Asia and a pinch from higher labor costs are playing a role in setting FedEx up for its weakest year of earnings growth since fiscal 2010, the shortfall is also a function of its own choices.
FedEx spent $4.4 billion in 2016 to acquire Dutch delivery company TNT Express NV. The deal substantially increased its exposure to the slowing European market and saddled it with an antiquated network that thus far has been mostly a giant money suck, although FedEx chief operating officer Raj Subramaniam says the company remains confident in the "long-term strategic value." FedEx now expects integration expenses to exceed $1.5 billion and for the process to stretch into fiscal 2021. Meanwhile, FedEx will spend $5.6 billion this year to modernize and adapt its network to more profitably handle the surge of e-commerce deliveries.
In a conference call to discuss the earnings, management was repeatedly peppered with questions about FedEx’s stagnant margins, negative free cash flow and whether it was really getting returns on all of this spending. Founder and CEO Fred Smith defended FedEx’s choices, saying the company wasn’t being profligate and that this was just the nature of the business. Chief Financial Officer Alan Graf pointed out that a decent chunk of the capital expenditure budget was going toward replacing 40-year-old aircraft in its delivery fleet. “I'm not letting one bad quarter decide how we're going to manage this business for the next five years,” he said.
To some extent, they are right. Parcel delivery is a capital-intensive business and it’s made particularly so by the fact that Amazon.com Inc.’s logistics aspirations grow ever-more ambitious. Addressing the Amazon issue, COO Subramaniam pointed to the investments FedEx had made to enhance its e-commerce capabilities, and the cost and productivity benefits from a more global network. Bloomberg Intelligence analysts Jitendra Waral and Lee Klaskow argue Amazon is several years and billions of dollars away from being a real competitive threat and that FedEx and rival United Parcel Service Inc. could head it off by developing an end-to-end logistics offering for e-commerce vendors that’s comparable to Amazon’s Fulfillment by Amazon service.
I was particularly struck by a question from Barclays Plc analyst Brandon Oglenski about whether FedEx needs to accept its size and maturity and “maybe focus more on returns and margins because I think that's what investors would like to see.” CEO Smith replied: “Well, so would we. I don't know what to say.” It’s the traditional dilemma for old-school industrial companies trying to adapt to a digital world. But as with W.W. Grainger Inc. and other industrial distributors, which have seen their business models upended by Amazon, it’s not clear when FedEx’s spending obligations and margin pressures will end. It may be that we are witnessing a more structural shift for FedEx’s economic profile.
Smith argued that the sluggish international revenue undermined FedEx’s ability to mitigate the impact from higher spending and he blamed a cyberattack of TNT’s systems in 2017 that cost the company $400 million in lost revenue and remediation expenses for sidetracking productivity improvements. I would contend those are business risks the company should have been better prepared for. With darker economic clouds on the horizon ranging from the U.K.’s exit from the European Union to a longer U.S.-China trade war, the company may be asking investors for more patience than they are willing to give.
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Brooke Sutherland is a Bloomberg Opinion columnist covering deals and industrial companies. She previously wrote an M&A column for Bloomberg News.
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