News / 'We may have made a mistake', admits FedEx as Q2 'disappoints'

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FedEx last night issued a “very disappointing” set of second-quarter results, with adjusted net income down nearly 40% to $660m, on revenues down almost 3% to $17.3bn.

The loss of Amazon’s domestic US contract, shorter peak period and the seemingly never-ending integration of TNT, which ”dragged down” FedEx, all served the company badly.

“Our Q2 results were very disappointing,” said Alan Graf, chief financial officer.

“The loss of volume from Amazon had a larger negative impact than the first quarter, since the FedEx Ground contract with Amazon expired in August.

“The headwinds and expansion of six and seven-day delivery, the loss of Amazon volume, and Cyber Week shifting to the third quarter accounted for approximately 60% on the Ground margin decline year-over-year,” he said.

Investors expressed confusion about the size of the hit from the shorter peak season, which resulted in 60% of the margin impact.

Fred Smith, chairman and chief executive, admitted the company may have made a mistake.

“We probably underestimated the cost … And then when we went into the peak season … we had an unbelievable response. We had 37m packages on Cyber Monday, and our plan was for 33m.

“And clearly, we didn’t do the greatest job of forecasting our costs and we were hit with a couple of other things, like the insurance reserves … and the more expense that’s required to operate a transportation company in general.”

The results also suggested that FedEx took a bigger hit from the ending of the contract with Amazon than it had previously admitted it would. Amazon has also this week temporarily blocked third-party sellers from using FedEx’s ground delivery network to handle Prime shipments during the holiday season.

Among a series of cost cuts, FedEx said it was replacing its aircraft fleet and would not grow it further.

“We are permanently retiring our fleet of 10 A310s,” explained Raj Subramaniam, president. “The reduction in flight hours would allow us to temporarily park 14 aircraft by the end of fiscal year ’20. We will also permanently retire another 29   aircraft over the next 30 months.

“It is imperative that while we reduce our cost to serve, we also drive higher yields to improve profitability. Capacity reductions will bring greater focus on revenue quality as we generate more compensatory volume through the network.”

Henry Maier, chief executive of FedEx Ground, added that an 8% reduction in flight hours is “tremendously large”.

“We’re not going to grow our fleet. We’re just replacing it. We’re tightening it … and reducing flight hours.

“Express’s domestic margins are fine. So, it’s the international that we got to keep working on, we’ve been dragged down by TNT. Some of it self-inflicted, some of it macro, we’re handling the flight hours, I think we’re doing everything that we can that we should be doing.”

One analyst suggested FedEx consider the swathes of job cuts that have been seen at the US railroads as they introduce Precision Railroading, noting that “some of the rails are cutting headcount 10% to 15% without severance costs, do we have any opportunity to do anything like that?”

But Mr Smith was quick to point out the differences between the companies.

“The rails are not even a remotely comparable business to FedEx. It’s essentially a business of maintaining tracks and automating to the extent possible … it’s not labour intensive.

“I don’t think you can keep the purple promise laying off thousands of people.”

He added that it was important for TNT staff to be “fairly treated”.

The integration of TNT continues to be problematic after three years, with network integration now expected to be completed during the first half of fiscal ’22. But clearly it hasn’t quite all worked out as expected, and the value was only “largely achievable”.

Mr Subramaniam said: “The rationale behind the TNT acquisition remains sound, the value that we estimated at the beginning of the process remains largely achievable.”

Mr Graf explained that there were still costs to be incurred.

“We now expect to incur approximately $325m of TNT integration expenses in FY’20 and $1.7bn in total through FY’21. We expect to begin realizing synergies from the integration of FedEx Express and TNT ground networks during FY’21. And these synergies are expected to increase significantly after the completion of the air network integration in FY’22.”

There was no specific mention of the court case in which shareholders are taking action against FedEx management, claiming that they effectively hid problems at TNT. A decision earlier this month means that two separate cases on the same issue have now been combined. Mr Smith merely noted “the litigious society we live in” as he talked about insurance reserves.

The management was, of course, keen to focus on its plan for the future and the positives, including the recent avoidance of new tariffs.

Mr Smith said: “Despite these issues, we remain highly confident in our strategies.”

Mr Subramaniam concluded: “I am not pleased with our financial results. And to that end, we have focused areas across the enterprise on B2B, e-commerce, international profitability, market leading revenue quality and operational excellence. In the short-term, this includes targeted actions to shore up our financial performance. We expect a reduction in intercontinental and domestic air capacity post peak and an overall reduction of costs in our express business. This action should result in the decrease of international and domestic flight hours by about 68% year-over-year in Q4.

“We continue to be very excited about our prospects ahead as we transform the ground company complete the TNT integration and the right size our network. Given a more stable economic environment, these measures should produce strong results for the corporation.”

You can see the full results here, and Loadstar Premium’s take on the results here.