Analysis: Hot (basis points) Tuesday – it's the turn of DSV, Keuhne & UPS
Looking for insurance policies
The attempt to spot a flaw in FedEx’s strategy is nothing new for those familiar with the affairs of the US express and logistics group. There is no sympathy for market leaders – they always have to deliver, in any market conditions, whatever the circumstances.
“UPS deal puts FedEx on the defensive” was The Wall Street Journal’s headline in the wake of the UPS/TNT tentative deal three years ago.
“FedEx made an expensive bet that a multibillion-dollar investment in new aircraft would give it a march over United Parcel Service on routes between Asia and the US, only to be outflanked by its arch rival in Europe,” the WSJ wrote on 19 March 2012.
For the record, since that report UPS’s stock has risen 22%, having underperformed the S&P 500 by 28 percentage points, while FedEx has recorded a stunning +85% performance on the stock exchange.
Once again, the pressure is now on FedEx management to show how business is done in Europe, where ongoing negotiations between Greece and its lenders have caused a huge amount of volatility in several asset classes, and which may last for some time.
Greece aside, trading conditions remains broadly challenging in the European transport industry, as testified by Deutsche Post-DHL’s operational performance over the last three quarters – during which, just as we predicted in mid-November, its equity valuation has gone nowhere.
DHL generates more than 60% of revenues in Europe, so is a very good proxy for performance there.
“DP-DHL stock looks a lot like an overpriced bond,” we said eight months ago, when its shares did not trade far off the 2015 low, recorded two weeks ago. This is relevant because FedEx’s strategy to reach across the Atlantic is not only a significant undertaking, as well as a potential distraction, but also because its recent set of financials raised eyebrows.
“If anything, FedEx’s fourth-quarter results send a warning sign to the freight and logistics industry,” a senior banker told me this week.
I am not sure that such remarks are entirely fair, although questions remain, particularly given that FedEx’s adjusted figures were good, but its unadjusted numbers less catchy.
Recurring and non-recurring items
The question is whether certain non-recurring items that hurt its fourth-quarter performance on a non-recurring basis may haunt it on a recurring basis in future. In fact, a big difference emerged between adjusted EPS of $8.95 and unadjusted, or reported EPS of $3.65 in fiscal 2015.
That’s nothing major, but some investors are nervous.
“I am bothered about currency risk, a lowly yield, muted growth for express and rising impairments,” a senior fund manager who owns FedEx stock argued.
Net earnings were heavily impacted by a $2.19bn mark-to-market pension accounting adjustment, which was expected in the last quarter, but the income statement also showed $276m of aircraft impairment and related charges, which contributed to a net reported loss of $895m for the quarter. Furthermore, while its cash and cash equivalents have risen by about $800m to $3.7bn from $2.9bn year-on-year that effectively cancels out its savings on lower fuel costs, down to $3.7bn from $4.5bn in 2014.
Capital spending for the year rose well above average to $4.3 billion.
Capex is expected to rise by about 10% this year, which may not be an issue as core cash flow is expected to rise, too, but then its TNT Express deal will likely draw even more scrutiny – the tie-up is unlikely to deliver huge revenue and cost synergies, so impairments and other one-off charges could again hinder its economic performance.
I also believe that Brent will comfortably hit $80 a barrel this year, continuing to rise towards historic highs into 2017.
That said, it’s early days to join those in the bear camp, and I am confident that management will be able to manage expectations despite the mounting pressure.
In recent months, disappointing second-quarter results were followed by strong figures in the third quarter, which once again, however, pointed to a rather sluggish growth of rate for revenues at its core express business.
This is relevant, because if FedEx doesn’t please investors on a quarterly basis, those in the bear camp may start questioning its capital allocation strategy, which should focus on growth and buybacks until growth and capital appreciation are on the cards, but should also pay attention to yield – FedEx’s forward yield below 1% is not that attractive.
In a follow-up call with analysts, much emphasis was placed on the performance of its ground division, whose growth rate and profitability are much higher than that of express, although ground revenues are about half of those of express. Virtually nobody paid much attention to impairments because they were expected.
So, where do we stand now?
On the one hand, this stock market darling seems to have pulled all the stops to secure a deal with TNT Express in early April – and its stock price has risen in line with the S&P 500 since.
On the other hand, it’s hard to say whether FedEx is getting its strategy right: fourth-quarter results left little room to the imagination, and contributed to one of its worst trading days for a long time.