Jonathan Chappell, Evercore ISI Senior Managing Director of Surface Transportation & Marine Transportation Equities, joins Yahoo Finance Live to discuss how severe FedEx's earnings pre-announcement is, a global economic slowdown, and the outlook for supply chains.
- Shares of FedEx are trading higher this morning after losing more than 20% last Friday. The company announced drastic cost-cutting measures and withdrew its full-year guidance last week, the news serving as a dire warning for global transportation and logistics stocks. Joining us with more Jonathan Chappell, Evercore ISI senior managing director of Transportation and Marine Transportation Equities.
Jonathan, I took a look at your note. You have an outperform rating on FedEx. You did lower your price target on the stock. I guess, my first question is, how do you categorize the severity of what happened with FedEx given what's going on in different regions like China, those lockdowns, the energy crisis going on in Europe and the Fed tightening here in the US? And is this FedEx specific or are we talking more about global woes here?
JONATHAN CHAPPELL: Yes, thank you for having me. So to categorize the magnitude, I don't think it's an understatement to say it's extreme. A 33% miss to first quarter, fiscal first quarter estimates and an effective 50% cut to the second quarter is something that nobody foresaw. You mentioned our long-term rating. We actually placed a tactical underperform trading call on FedEx stock on August 23 with the anticipation that there might be a miss in the fiscal first quarter and a lower of the full-year 23 guidance given a lot of the macro headwinds.
To the second part of your question, I think there's a healthy dose of both of those issues. There's clearly a slowdown in certain parts of the global economy. Europe is going through its own recession for energy reasons and just general consumer slowdown and what we're seeing in China as it relates to the impact of 0 COVID lockdowns there. But FedEx does a lot of export business from China.
So when we talk about the amount of business and the margin hit on their express business, which would be China exports to the Western world, it's not just clearly an Asian story. And there is an impact from the Western world and, I would say, the US economy as well. But there is a very strong element of FedEx-specific cost issues here that I think have taken the magnitude and sent it to that extreme level.
- So, Jonathan, it sounds like you're saying that FedEx is a lot more exposed to some of those global headwinds that we've been talking about. I mean, how do you think that investors should be looking at this compared to some of its competitors?
JONATHAN CHAPPELL: Well, at this point, I think it should be placed in the penalty box until further notice. They report earnings on Thursday night. Remember, this was a preannouncement, not an actual earnings release. So we had a preannouncement last Thursday. We'll get the actual earnings release this upcoming Thursday.
And I think the key is going to be how do they explain the sense of urgency, the timing, and the magnitude of some of these cost initiatives they've pointed out because it's clearly more of a FedEx issue than it is a broader transportation issue, even though the broader space certainly has some macro headwinds. I don't think we're going to see a peak season anywhere close to what we've seen in the last two years as it relates to the consumer and the retail going into the holiday season.
So we're cautious on the group as a whole. We downgraded UPS on the same day that we put the tactical underperform trade on FedEx. But UPS reiterated their guidance in a sell-side meeting a couple of weeks ago. So I don't think you're going to see nearly the magnitude as we go through this earnings season or the rest of the group.
But for FedEx, I think to get out of that penalty box, there needs to be a deeper explanation of how they're going to react to some of these macro headwinds a bit more acute to their network than to the rest of the transportation world. And then we'll actually need to see it in principle, probably not as early as the second quarter of the fiscal year, but hopefully as early as the second half of their fiscal year, which would cover the first half of our calendar 23 and then more importantly going forward.
- And, Jonathan, it appears that their shipping and air freight was the one that has been taking the biggest hit when it comes to margins more than ground. How significant is that? And when we're talking about cost-cutting measures that FedEx announced, how effective do you think that they'll be?
JONATHAN CHAPPELL: Well, I think it's very significant because Express is their core business, number one. And number two, it wasn't really as much as investor focus as the self-help opportunities at the ground. They had their first investor day in a decade in late June in Memphis, which we attended. And the investor focus at that time was very much on how can they get the ground margins back to double digit levels.
Well, ground, as you probably saw from the release last week, they missed revenue by about $300 million, but the operating income was a little bit better than expected. This Express situation is very extreme and that's more of a fixed cost business. It's more of an Asian and European exposure.
And again, there's a lot of self-help opportunities here, but the jury's still out. They announced a lot of cost initiatives in June with maybe not as much clarity as one would have hoped for, and by their own admission, frankly. And now they announced these new cost initiatives as part of this preannouncement, but again, with no detail around the timing of implementation, when we can start to see the magnitude.
So I think Thursday night will be a first step. I'm getting a little bit more meat on that bone. But it'll probably take several quarters for us to actually see it impact the margin in a favorable light.
- Jonathan, really quickly, we're looking ahead to what is one of the busiest seasons and the holiday. And so the sector as a whole, how big of a pullback are we likely to see?
JONATHAN CHAPPELL: You mean from an equities perspective?
- From a volume perspective going into the holiday season.
JONATHAN CHAPPELL: Well, the comps are very difficult. So when you comp to 2021's peak season, I mean, not only did we have still the impact of COVID and still an incredibly strong consumer, but you had a lot of what we call double buying or early buying by the retail community because, remember, the peak season of 2020, we had just come out of the pandemic, so to speak, and we were still living in a very different way.
But the demand was extreme and the supply chain bottlenecks were also extreme. Therefore when we got to the peak season of 2021, retailers were very panicked and they overbought and inventories are really elevated right now. So I think volumes in a best case scenario are going to be flat, but more realistically will probably be down somewhere in the mid to high single digits. And certain retailers are still getting rid of inventory at a very cut-rate price to try to clear up space as they look to 2023.
- Jonathan Chappell, good to have you on today. Evercore ISI senior managing director of Transportation and Marine Transportation Equities.