FedEx: Limited Margin Growth & Challenging Business Environment (NYSE:FDX)

FedEx Freight truck

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FedEx (NYSE:FDX) is a world-renowned logistic company that provides transportation, e-commerce, and business services. Its business segment includes FedEx Express, FedEx Ground, FedEx Freight, FedEx Services, and FedEx Office.

FedEx has shown good top-line results in the latest Q3 2022 earning call. The total revenue is $23.6 billion, a 10% YoY growth.

Despite the positive Q3 2022 results, several factors might hamper the company’s growth. These factors include the lingering effect of COVID, tight labor market, the ongoing conflict between Russia and Ukraine, supply chain disruptions, high energy prices, and inflationary pressure.

FedEx’s major competitors include United Parcel Service (UPS) and Amazon (AMZN).

1. The lingering effect of the pandemic

During the pandemic, the labor market was competitive due to the labor shortage and increasing labor costs. The lack of a physical labor force has caused a delay and disruption in logistics. However, as the omicron situation has improved and the countries and the workforces are slowly picking up their pace, it certainly brought some hope that the problem and the delay can be resolved.

Despite the relaxation in the ‘physical’ labor market and the availability of the labor pool to hire, the wage pressure will still be a mid-term problem. The latest earnings call mentioned that the market labor impact is estimated at $210 million year-over-year. As the tight labor market situation gets resolved, we were hoping to see that it translates to a positive effect on the company’s operations and potential financial improvement.

With the rising COVID cases in China, there have been reinstated restrictions in several parts of China. This has caused delivery disruptions or, in some cases, a temporary service suspension for the company. The negative impact from China will affect the global supply chain through reduced actual supply, and its impact will be felt beyond China and Asia.

From the company’s perspective, there are some opportunities to look at – In the European region, the operation efficiency and top lines can be improved. In North America, the FedEx ground business has to utilize the revenue growth and work towards margin improvement.

There are changes that the current challenges, such as tight labor, wage pressures, and volatilities in energy prices, may accelerate the speed of transformation of logistic innovation with robotics and advanced computations. FedEx has a history of testing autonomous vehicles and plans to test autonomous drones. Although we never can predict whether the company will be the winner of these future changes, they seem to be in the right direction to leverage the opportunity.

2. The war has caused an even more challenging business environment

The war will hurt the world’s economy. Among the vulnerabilities, it has spiked the oil price and further weakened the global supply chain. Despite the company suspending all services in Ukraine, Russia, and Belarus and mentioning that the profit impact from that region is not material, there are other inevitable indirect impacts to the business due to the interconnectedness of global economies.

Energy price is one of the cost components of the company’s business, representing about 5% of the operating expenses. The increase in energy prices is attributed to several factors, including a surge in demand due to the post-pandemic, the Biden administration’s domestic energy policy, and the ongoing Russia-Ukraine war.

The company reviews its fuel surcharge regularly to keep its base shipping rate while adjusting the surcharge to cover the increase in fuel price. This is a common practice to support competitive delivery charges while offering their customers comprehensive services. Standing from a consumer point of view, this increase in the shipping cost is born by the consumer.

Consumer confidence is lower with inflationary pressure and higher interest rates (future). With a sticky wage growth compared to the price increase for goods and services, it will lead to weaker GDP and lower consumption and spending. These, coupled with pressured sales growth and concurrent margin compression due to remnants of pandemic effects in labor forces and energy costs, will be a challenging environment for the company.

3. Despite the e-commerce growth translating to more robust revenue growth, there is limited margin growth

COVID-driven e-Commerce sales growth has allowed the logistics businesses to accelerate the sales growth for years ahead of its anticipation. However, if we look at 2021 to 2022, we only see margin growth at 3% YoY. This casts a serious question on whether the giant logistics companies benefit from e-commerce growth. The limitation of the margin and the cash flow growth is driven by competition among existing players, an operation model that relies on people and fuels rather than technology, and threats from new players and new technology (for example, Amazon’s direct logistics with unmanned technologies).

Valuation and opinion

This is my price range for FedEx:

FDX Stock Valuation

Author’s financial model (Author)

FedEx is a highly recognizable brand name and has built its niche area through the years. FedEx announced a $5 billion share buy-back program last year (10% of the current market cap, or approximately 2% per year on a 5-year program). Coupled with the dividend yield of 1.5%, the annual return to the stockholder is at a reasonable 3.5%. However, with the challenging macro-economic situation and low expectations in the growth of margins and cash flow, I view the price as at its full value but not attractive to enter into a buy position.

From a long-term perspective, it is still interesting to monitor the company’s plan for autonomous vehicles and drone delivery and whether the company can capitalize on the opportunities and improve the process efficiency. For long-term fundamentals, I view this capitalization as an unavoidable mandate to compete against the existing competitors and the new entrants like Amazon in the foreseeable future.


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