Analysis - declining cash levels could lead Maersk on a $5bn new equity quest
I have been thinking a lot about the cash and liquidity profile of Denmark’s AP ...
“Every time we make an investment decision at FedEx we ask ourselves: what is the return on investment?” – Fred Smith, FedEx founder and chief executive.
If FedEx’s latest financial performance is anything to go by, it won’t be long before the company has another multibillion-dollar deal under its belt – although, even in its current shape and form, it doesn’t have much of an issue in creating more shareholder value.
Nonetheless, this is a pivotal time for integrated transport companies, with DP-DHL and UPS also readying to fend off the threat posed by big shippers that might be looking for deeper integration of supply chain services.
Little to fear
These three major transport companies have little to fear and are clearly well prepared. Not only do their shares trade at all-time highs, but their run seems unstoppable, based on solid fundamentals and boosted by core CPI trends that, admittedly, are less bullish lately than before.
The most recent news that Amazon has bought more land at Cincinnati airport for $1.5bn to fund its air freight hub development comes as FedEx is about to open a new “mammoth” hub in Shanghai.
FedEx is busy on several fronts every day of the week – it recently held a Saturday job fair to hire 800 workers at its world hub in Memphis – and I believe there could be inorganic growth plans, too.
In recent years, FedEx has been busy in M&A, with GENCO – now FedEx Supply Chain – and TNT Express the highlights of a deal-making strategy where at least one deal a year is traditionally sealed.
On this matter, management is fairly relaxed, “but they are looking”, according to a banking source close to FedEx’s thinking. “They always are,” I replied, knowing FedEx is always ready to grab an opportunity, just as it did with TNT Express soon after the proposed takeover of the Dutch courier by UPS fell through.
Latest news points to a company that is in full swing when it comes to investing in its infrastructure network, but its financials also prove that I was right last summer to argue that it might find itself in a position where it has to compromise between growth and profitability, and soon it might have to look for precious M&A-led synergies, given trends for some of its core operating costs.
In the six months ended 30 November, group revenues rose to almost $118 a share, up 6.8% against the first six months of fiscal 2016, which is implied in the figures contained in the tables below.
Its main variable and fixed costs – staff and purchased services, or COGS – grew at group level, but FedEx showed a great deal of financial discipline in the first half of its fiscal year, churning out a “tier-one” profit (effectively sales minus staff, minus COGS) of $13bn, or $48.7 a share versus $45.7 a share one year earlier, up 6.5% year-on-year, which was broadly in line with trailing revenue growth.
Undoubtedly, this is a remarkable achievement, given the amount of investment required in operating costs. Other considerations, however, are not as good as its tier-one profit performance; quite simply because there are costs that FedEx cannot control, which lead to a meaningful drop in core underlying earnings, falling operating cash flows as well as mildly lower cash balances.
It is strong financially, but excluding the aforementioned staff and COGS costs, FedEx had some $10.6bn of additional costs (almost worth $40 a share) that rose about 10% on a comparable basis (from $9.7bn in the first half of 2016), determining a lower operating income, down 2.1% to $2.37bn, or $8.8 a share – that implies an ebit margin of 7.5% for the first six months of business versus 8.2% one year earlier.
Such costs as rentals and landing fees (up 3.8%; 5.2% of revenue), depreciation and amortisation (up 1.9%, 4.7% of revenue), fuel (up 16%, 4.8% of revenue), maintenance and repair (up 13.9%, 4.2% of revenue) and “others” (up 9.2%, 14.7% of revenue) all rose significantly. When interest and taxes were factored in, a drop in net earnings, down 4% on a fully diluted basis, could not be prevented, as the table below shows.
There is little it can do to manage these items. But when operating costs become heavier, M&A could well be the answer and, as I have argued in the past, the GLS unit of Royal Mail is particularly enticing and FedEx could easily afford to bid for the unit, or Royal Mail in its current form, (it would likely cost less than 10% of its own market cap of $72bn).
Pressure on its operating profit almost passed unnoticed in the investor community, at least judging by the all-time high that FedEx stock recorded in the wake of its announcement at the end of 2017,
“It was as if everybody knew that FedEx would continue to do whatever it takes to deliver value to shareholders, although some obvious headwinds persist,” one London-based trader dealing with US accounts added.
However, divided growth also plays a part in this corporate story.
The quarterly dividend rose 25% to $1.50 from $1.20 one year earlier, which was great to see for a company where the success of the ground unit and a strong, rising yield associated with the dividends, coupled with solid growth rates, inevitably remain two crucial value-drivers. In many ways, FedEx is challenging UPS to do more, and could continue to attract a rising number of investors, given a dividend growth rate that greatly outpaces that of its domestic rival.
Finally, a last word on latest market reports saying “FedEx is expanding the business unit led by its founder’s son by consolidating specialty logistics and e-commerce solutions within FedEx Trade Networks”.
As reported in Memphis local paper The Commercial Appeal last summer, 39-year-old Richard Smith “was promoted to president and chief executive officer of FedEx Trade Networks”, and that announcement was made at a key time in Fred Smith’s succession plan, the final outcome of which could well hinge on deal-making in a freight forwarding services unit led by his son and likely to become increasingly important for the group.