NEW YORK, NY - DECEMBER 19: A FedEx worker unloads packages from a truck in the Financial District, ... [+]
It seems that one of the hardest things to do is among the easiest to say — deliver a package on time.
This comes to mind in considering FedEx’s latest earnings report. FedEx — which got started delivering packages to businesses — has yet to master on-time delivery of holiday packages from warehouses to homes.
That is why Amazon built its own network for delivering packages. FedEx’s loss of Amazon’s business and its struggle to adapt to that loss are the major reasons why FedEx reported disappointing earnings.
I expect FedEx to keep disappointing investors unless it sharply lowers their expectations. While UPS is doing better, residential delivery is inherently less efficient than business delivery, so I would not jump into the shares of either company.
(I have no financial interest in the securities mentioned in this post).
How bad was FedEx’s report? It missed earnings expectations by 10%, fell $260 million short of revenue forecasts and was 3% lower than the year before, and lowered 2020 guidance to around 10% below what Wall Street expected, according to CNBC. FedEx shares — which trade 38% below their January 2018 high of about $262 — dropped 6.7% after the announcement.
Here are five reasons that FedEx could keep disappointing:
- Amazon is competing with FedEx by delivering about half of its own packages and is temporarily restricting third-party sellers from using FedEx for some deliveries
- UPS is taking up some of the slack
- Blackstone’s micro warehouses are siphoning traffic from FedEx’s hub
- China tariff uncertainty
- Plunging profit — down 40%
Amazon Vs. FedEx
The shipping business has changed, Amazon is creating the future and FedEx is struggling to catch up. Specifically, global air shipments — FedEx’s core business — is declining while delivering packages ordered online to peoples’ houses is surging, according to the Wall Street Journal.
FedEx — which used to be Amazon’s shipping partner — is now its competitor. FedEx is investing in a bid to keep up.
From Amazon’s perspective, FedEx’s household service delivery quality is unacceptable. Amazon announced the day before its earnings announcement that due to FedEx’s “poor delivery performance,” third-party sellers were blocked from using FedEx’s Ground Network to deliver Prime shipments, according to the Journal.
If FedEx’s service improves, these merchants which represent 58% of Amazon’s total merchandise sold, according to CNBC, could be permitted to use FedEx’s service.
Cambridge Capital Managing Partner, Benjamin Gordon, is skeptical of the timing of Amazon’s announcement. As he said in a December 18 interview, “Why did Amazon make this announcement the day before FedEx’s earnings release? Was this designed to punish FedEx? Note that earlier this year, FedEx and Amazon parted ways, in what Amazon labeled ‘a conscious uncoupling.’ They deserve kudos for their sly cultural reference to Gwyneth Paltrow. But in reality, FedEx pulled out when they concluded that Amazon had shifted from customer to competitor.”
Many of these merchants were shocked by Amazon’s sudden decision and are scrambling to come up with other ways to deliver packages on time.
Nonetheless, the complaints about FedEx’s service quality are compelling. According to CNBC, Karin Isgur Bergsagel, an Amazon seller, "I've had FedEx ground packages from Wayfair showing up a week late. [Amazon’s FedEx] ban represents across the board service delays impacting all shippers through FedEx Ground, not special bad treatment for Amazon sellers."
Amazon is leasing cargo planes and “buying thousands of vehicles” to expand its own delivery capabilities. The Journal reported that analysts expect Amazon to handle roughly half its package deliveries this season.
This is costing FedEx a considerable amount of revenue — partly due to the loss of Amazon’s $900 million in shipping contracts, according to the Journal.
UPS Taking Advantage of FedEx’s Vulnerability
United Parcel Service is taking some of the business that FedEx is losing. UPS has recently invested significantly to ”expand and automate its network to handle more online orders,” according to the Journal, which reported that UPS has expanded its air shipment network to handle more packages from Amazon and others.
As a result, UPS’s financial results have been far better than FedEx’s. In October, UPS’s profit and revenue rose and it maintained its guidance for 2019, according to the Journal.
In its third quarter earnings call, UPS CEO, David Abney, said that “consolidated revenue grew 5% and operating profit grew more than 20%, creating strong operating leverage and the highest quarterly operating profit in the company's history. Margins expanded in all three segments...Our integrated network is running well, and widespread adoption of next-day delivery is an excellent fit with our expanded air and ground capabilities.”
Blackstone’s Micro Warehouses Siphoning Traffic From FedEx Hub
Amazon and UPS are not the only big challenges facing FedEx. Gordon views Blackstone’s investment in so-called “micro warehouses” located in major urban markets as “changing the nature of last-mile logistics shipments. Some packages that might have moved by a FedEx plane from Memphis are instead being trucked to a last-mile warehouse, and then delivered to consumer by car, van, or even cargo bike. As a result, freight is leaking out of the FedEx network.”
Gordon believes that FedEx should consider acquiring a last-mile logistics network. “This would give them a mechanism to recapture this freight that is leaking out of their network,” he argued.
China Tariff Uncertainty
Another reason for the drop in FedEx’s revenue is a drop in demand for global shipping instigated by U.S. China tariffs. As the Journal reported, “a slump in global trade has damped demand for air shipments.”
Demand for global air shipments will rise in 2020 if tariffs are partially lifted. Details of a so-called phase one deal with China are unclear. Yet a Trump tweet claimed “that his administration would cut preexisting tariffs on $120 billion worth of Chinese imports from 15% to 7.5%, while maintaining its 25% tariffs on $250 billion worth of Chinese goods,” according to CNBC.
Given the lack of validated information, there is considerable uncertainty about whether this will boost global shipping demand.
Lower Profit
FedEx’s profit fell a whopping 40% in the quarter. The reason is a trifecta of economic terrors: lower demand for its main line of business, fierce price competition, and rising costs to build up a residential delivery capability. Its operating margin declined by more than half from 5.5% to 2.2%, according to its quarterly report.
On December 17, FedEx executives said that expenses for the November 30-ending quarter were higher-than-expected as it “modernizes sorting centers and shifts to year-round seven-day residential delivery” and “cautioned costs would be elevated during the peak shipping season now testing its limits,” according to the Journal.
Unfortunately for investors, UPS faces similar challenges. On December 14, BMO downgraded UPS to market perform, according to MarketWatch.
The problem is that residential delivery is inherently inefficient. As BMO’s Fadi Chamoun, wrote, “Rising e-commerce volumes are increasingly becoming the dominant share of small package delivery volumes, pressuring operating margins and return on invested capital for related companies. The biggest driver of profitability for the industry is drop density, which is significantly lower for residential deliveries than for business deliveries, and we see no reasonable path toward improving business-to-consumer drop density.”
FedEx expects lower earnings for the full year. CNBC reported that Refinitiv expected FedEx to report full-year EPS of $12.03. On December 17, FedEx reduced its EPS forecast from a previous range of $11 to $13 per share to a lower one between $10.25 and $11.50.
″Our revised guidance reflects lower-than-expected revenue at each of our transportation segments and higher-than-expected expenses driven by continued mix shift to residential delivery services,” said CFO Alan Graf Jr., according to CNBC.
Stay away from FedEx stock and keep an eye on UPS to see whether it can surprise those who share BMO’s pessimism.
