When a company becomes a verb, I always feel that a solid competitive moat has been achieved, which can be incredibly hard to disrupt. FedEx (FDX) will be a term used by many in place of mailing or sending packages, but I fear it may be under threat in the coming years after announcing a spin-off for the Freight segment of the company. The sector is undergoing major changes, and with management likely to face some seriously complex operational and financial challenges over the coming years, I’m rather bearish.
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Key Issues Arising
I see a few major issues ahead for the company. The separation of FedEx Freight will lead to the creation of two independent companies. While the new Freight company may see a range of improvements arising from this structure, such as operational focus and market-specific strategies, the same cannot be said for the parent company. While various synergies have been realized over the years between the various FedEx segments, the removal of such a large part of the company’s operational footprint could lead to major challenges with customer solutions, network operations, and many more critical areas of the business.
Historically, the Freight segment has provided about 10% of total revenues. With revenues declining 0.9% since last year, now at $21.97 billion, there is plenty of pressure on the company to realize operational efficiencies.
Efforts are underway with the firm’s DRIVE program, which aims to make $4 billion in cost savings by the end of the year. As impressive as the ambition is, I’m not entirely sure if these are making a meaningful impact yet. Operating margins are, in fact, down slightly to 6.3% in the last year despite some incremental savings.
I’d also be concerned about how the spinoff will add another layer of complexity to these changes. Management has also repeatedly revised EPS guidance downwards recently, now at $19-20 for FY25. If further revisions are negative, investors may see that this ambitious plan for operational efficiency amid a complex restructuring operation may be too far.
The company does have a fairly mixed balance sheet, with a solid $5 billion in cash, but this is somewhat overshadowed by a massive $37 billion debt. I’m encouraged to see management devoting some major investment to share buybacks at this level, but this will need to be continued over the long term to maintain investor confidence.
Broader Challenges for FedEx to Address
In addition to the company-specific challenges, I’m concerned about the wider sector posing a threat to FedEx over the coming years. While competition from established players such as United Parcel (UPS) is nothing new, several major companies are moving into the logistics sector, most notably Amazon (AMZN). With the ability to bundle multiple services and a clean and well-liked interface, many users may look to the e-commerce giant in place of traditional logistics operators.
Then there are the concerns around a slowdown in the wider industry and economy. Where the company has an enormous reliance on business-to-business (B2B) shipping, it may be particularly impacted by geopolitical tensions or trading tariffs. With the U.S. Manufacturing PMI, or the Purchasing Manager’s Index, contracting in 24 of the last 25 months, there may be issues in the industry that management is unable to fully mitigate.
Furthermore, the company’s valuation is fairly mixed when considering the wider market. While a P/E of about 17.5 is not too extreme compared to some companies in the sector, I feel like it reflects a lack of confidence in the future growth potential. Where analysts are continuously revising price targets down, and where price targets are not as high as they potentially should be for a company with this level of high risk, high reward.
Considering the Future
Clearly, the two companies’ futures as the spinoff progresses are fairly uncertain. As a result, I have three key points I’d want to keep a close eye on as a potential investor.
1– What exactly does management plan to drive revenue growth across the existing segments? Are these sufficient to offset the loss of Freight revenues?
2– How will the separation of the companies impact integrated solutions? Will commercial agreements between the entities be enough to sustain the operational improvements identified?
3– Beyond the DRIVE program, what is management doing to improve cost structures and profitability?
If management can address these items in a way that impresses investors and analysts, there could be a successful future ahead for all entities. However, one thing the market hates more than anything is uncertainty, and if these points cannot be answered soon, I see no alternative to continued downward revisions and a turbulent time ahead.
Summing Up
Any spinoff is a major moment for a company, which can often see genuine success. Still, it can also leave a parent company struggling with weak demand, rising costs, and risks associated with limited integration. I’m finding it hard to shake off my bearish sentiments here without clear answers to the company’s next steps. As successful as the company may be if progress can be made, I see more lucrative and less risky opportunities elsewhere.
