It wasn't long ago that the joke on the street — "profit warnings come in four sizes: small, medium, large and FedEx" — was somehow expected to turn into the company's epitaph. The trade war with China, a split with customer-turned-competitor Amazon, service quality falling to abysmal lows and higher operating costs had all taken their toll, sending shares to a floor of x10 earnings in early 2020.
But many shall be restored that now are fallen — as many shall fall that now are in honor. Fedex counts among the big winners of the COVID-19 crisis. Revenue is up $15bn, from $69bn in 2019 to $84bn last year, while earnings grew fivefold, from $1bn to $5bn. Return on equity went from anemic to 25%, notwithstanding a $2bn debt paydown. What a difference a pandemic makes.
These impressive results did not go unnoticed by investors, of course, as Fedex's market cap more than doubled over the last fifteen months. According to analysts — whose consensus is surveyed in real-time by MarketScreener — this momentum has yet to run dry, in part because the chronically underperforming operations in Europe inherited from the acquisition of Dutch group TNT are picking up.
The Old Continent remains a difficult market though. In the U.S., FedEx sports solid duopoly-like economics across the majority of its business lines. In Europe, the market is fragmented and smaller-scale regional players with little operating leverage compete aggressively on costs. Consolidation efforts have helped with commercial logistics, but not so much with residential delivery.
This is because there are no bulk logistics with the consumer side of the business, and too many stops per route. Add the raging shipping war between retailers — many of which now promise same or next-day delivery, often at no cost in exchange of memberships — in the backdrop and the explanation for low margins and subpar returns is found.
Amazon opted to massively outsource last-mile delivery to third-party contractors. After years attempting to defend their brand equity, others are doing the same, including FedEx. Meanwhile, the e-commerce giant is pouring cash upstream — into warehouses, trucks, cargo planes and IT — in an effort to reduce its dependence on carriers after rates have ballooned.
Keeping pace with the new paradigm should prove a lasting challenge, but fortunately it's a booming market and there's room for everyone. Big players — such as FedEx and UPS — own massive fleets and infrastructures that are almost impossible to replicate. Such scale comes at a cost that few can afford. Provided that they find the right recipe in terms of controlling costs, their moats remain unassailable.
Amazon is the elephant in the room, but other retailers are not so keen on giving their delivery business to their arch rival. This is where FedEx plays its card. With a global network spanning 680 aircraft, 200,000 vehicles and 600,000 employee, the Memphis-based company handles more than twenty million shipments each day. Again, these credentials matter in a business where scale is paramount.
Other carriers have rushed to build up theirs, but they may face difficulties adding capacity once interest rates recover — if they ever do. On that front, and as in many other industries, the last decade is offering investors a distorted picture of economic rationality.
The surge of e-commerce — including in clothing, groceries and big ticket items — enabled FedEx and UPS alike to claw back some of their pricing power. Many retailers now have vital dependency on their shipping partners. This new paradigm is likely here to stay. It means that FedEx will mint money if management deliver on their restructuring efforts.
Recent momentum has sent the share at $300 — a price that put them at just x14 forward earnings, below the market and their 10-years average alike. Fuel costs and wages are rising, but volumes as well, and so far they're making up for it. Unlike UPS, which gets the two-thirds of its revenue from the U.S., FedEx is more exposed to international shipping.
That's a strength in good times, but also a weakness in bad ones. FedEx has a higher fixed costs structure, so even modest slowdowns hit its profits hard. A prolonged trade war between the U.S. and China would leave no place untouched, as an economic decline in Asia would immediately ripple to Europe and other parts of the world.