FedEx: Cost Cuts Will Benefit Customers Over Investors

seekingalpha05-25

FedEx's stock has declined ~5% since I covered it last year, indicating continued stagnation in line with the economic trend.Technology savings may not improve margins, as its competitors appear to be...

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Fundamentally, I believe its issues are similar to those faced by airlines. The risk of a manufacturing or consumer demand recession could cause a poorly timed profit decline. On the other hand, continued macroeconomic stability may lower profit margins by encouraging more labor cost growth. The company's position today is not markedly different from then, but critical changes have occurred. The stock is down 5% since I covered it, which is notable given that the S&P 500 has risen ~18% since then. We've seen a continued decline in its sales and mild pressure on its operating margins. In my view, the firm is struggling with combined headwinds from macroeconomic stagnation or weakness combined with labor cost pressures. With this in mind, it appears to be a good time to provide an updated outlook on the firm, its valuation, and the macroeconomic landscape. Technology Improves Pricing, Not Margins As noted in my previous article, the company appeared to have potential savings opportunities by utilizing emerging technologies. The company's CTO pointed to a significant $4B in cost savings from technology-focused consolidation and improved efficiencies. Thus far, we've seen declines in its COGS and operating expenses; however, that has been offset by similar declines in its sales, resulting in no margin improvements. Indeed, while technology may improve efficiency, we must assume that UPS and others are pursuing similar aims. Thus, these measures keep it competitive for customers instead of benefiting its bottom line directly. See below: Data by YChartsIn my previous article, I believed that FedEx had strong long-term prospects with high shorter-term risks. Since then, it seems that many of the issues are being stretched out, while its cost-saving measures are likely resulting in lower prices. Both UPS and FedEx are not keen on raising prices, particularly as the aggressive COGS growth spurred by supply-side inflation slows. To me, AI technology may still lower logistics (and similar) spending over the coming years, but UPS, DHL (OTCPK:DHLGY), and others are all seemingly pursuing the same ends. Further, if fuel prices rise, that may offset any savings. FedEx's COGS has declined over the past two years due to lower fuel prices. Fuel prices are the lowest they've been since around the beginning of the inflationary spike in 2022. There is a decent correlation between FedEx's COGS and fuel prices. See below: Data by YChartsTheoretically, higher fuel costs are passed on to customers. However, since customers will shift toward the cheapest carrier, the same can be said for technology savings when pursued across the industry. Given the high geopolitical risks in key global energy markets, I believe the risk of a more considerable spike in fuel prices is underappreciated. On top of that, it is unclear if fuel prices are primarily low due to the draining of the Strategic Petroleum Reserve, as that has created an artificial market glut. FedEx's revenue and sales expectations for the next two years are highly correlated to the Freight Transportation Services Index, which measures freight volume. This index briefly returned to its pre-COVID peak in 2022 and has declined since. FedEx's sales and its outlook have followed suit: Data by YChartsIn my view, the US economy is neither strong nor necessarily weak. Of course, analysts can point to various data that will likely either show a positive or negative economic position. With unemployment low and real GDP growth positive, the economy is not in a recession. However, if we look at the \"real economy,\" excluding the technology and digital spheres, we start to see data that appears more in line with most people's experience. Consumer sentiment is weak, and with real wages falling again, savings levels and real retail sales are declining. With the manufacturing PMI just below 50, the US manufacturing industry is in a very slight contraction. According to the Cass Freight Index, total ground shipments across North America are also declining. Historically, these two measures are well-associated with FedEx's profit growth: Data by YChartsAs things stand, it appears more likely that FedEx's income will decline slightly over the coming year. The analyst consensus predicts its income and sales will rise, with its EPS anticipated to increase by 20% during its fiscal year 2025 (which begins on June 1 of this year). Its sales are also expected to grow, but only by around 3%, signaling that the expected income growth will come from improved margins due to its cost-cutting measures. I am not convinced those cost-cutting measures will not be primarily passed on to customers (through lower prices due to competition). In my view, all of its competitors are also looking to leverage AI and similar technologies to reduce costs. This may result in a temporary profit margin improvement, but not necessarily one that lasts. Further, with the US physical goods economy declining, albeit slowly, there remain added cost pressures and headwinds for the firm. The fact that real hourly incomes are seemingly declining again may indicate a worsening of the macroeconomic conditions. As the data stands, a crash appears unlikely, with a prolonged slowdown that appears more like stagnation seeming most likely. That is a continuation of the trend hampering the industry since 2022. What is FedEx Worth Today? Based on its expected EPS for the current fiscal year, FDX's forward \"P/E\" today is about 14X. To me, that is reasonable, if not slightly high, assuming the risk that its EPS contracts due to economic circumstances. Of course, my view is at odds with most analysts, who expect the slowing labor cost pressures and technology efficiency measures to improve its EPS markedly by 2026. Looking at its forward \"P/E\" with the analyst two-year ahead EPS expectation, we're seeing a 10X multiple and a 6.1X forward \"EV/EBITDA.\" See below: Data by YChartsFedEx's forward valuation aligns with the levels held since 2020. This valuation is below UPS's level and just above that of DHL. Thus, the company may be reasonably valued today if we assume relative economic stability will continue. Personally, based on the data, it seems that the manufacturing and goods economy will more likely decline, potentially at a faster pace over the next two years, if fuel prices rise as I expect. The Bottom Line Compared to last year, the significant difference facing FedEx is that it is not likely to face the same labor pressures as it was. At that time, truck driver and pilot labor action was hot, and companies competed for workers despite low sales growth. There are still some issues relating to its pilot union threatening a strike. The risk remains, but from what I've seen in airlines following the collapse of Yellow and with transportation demand falling/slowing, I do not feel there is as much leverage for labor action as there was in 2022. That may change, but I now think FedEx should see its COGS and operating overhead decline over the next two years. However, unlike most analysts, I think its sales will decline proportionally, if not more, if the goods economy slows.  I remain mildly bearish on FDX and believe it is more likely to decline than rise over the next year. It is not clearly overvalued, but it is also not discounted, given its key risks remain. That said, for FDX to decline significantly, we'd likely need to see a faster drop in the freight industry on a macroeconomic level, which is far from certain. Thus, I would not bet against FDX as it stands now. I did see it as a potential short opportunity when I covered it last. However, its relative stability since then makes it seem like it will likely face years of continued stagnation rather than a rapid decline.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.29.2","shortVersion":"4.29.2","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2438984620"}