FedEx Corporation (NYSE:FDX) Q4 2023 Earnings Call Transcript

FedEx Corporation (NYSE:FDX) Q4 2023 Earnings Call Transcript June 20, 2023

FedEx Corporation beats earnings expectations. Reported EPS is $4.94, expectations were $4.89.

Operator: Good day, and welcome to the FedEx Fiscal Year 2023 Fourth Quarter Earnings Call. All participants will be in a listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Mickey Foster, Vice President of Investor Relations. Please go ahead, sir.

Mickey Foster: Good afternoon, and welcome to FedEx Corporation’s fourth quarter earnings conference call. The fourth quarter earnings release and Stat Book are on our website at fedex.com. This call and the accompanying slides are being streamed from our website, where the replay and slides will be available for about one year. Joining us on the call today are members of the media. During our question-and-answer session, callers will be limited to one question in order to allow us to accommodate all those who would like to participate. I want to remind all listeners that FedEx Corporation desires to take advantage of the safe harbor provisions of the Private Securities Litigation Reform Act. Certain statements in this conference call such as projections regarding future performance maybe considered forward-looking statements within the meaning of the act.

Such forward-looking statements are subject to risks, uncertainties, and other factors, which could cause actual results to differ materially from those expressed or implied by such forward-looking statements. For additional information on these factors, please refer to our press releases and filings with the SEC. Please refer to the investor relations portion of our website at fedex.com. For a reconciliation of the non-GAAP financial measures discussed on this call to the most directly comparable GAAP measures. Joining us on the call today are Raj Subramaniam, President, and CEO; Mike Lenz, Executive Vice President, and CFO; and Brie Carere, Executive Vice President, Chief Customer Officer. And now over to Raj.

Raj Subramaniam: Good afternoon, everyone. Before I start my remarks, I first want to acknowledge the upcoming retirement of Mike and his terrific contributions and accomplishments at FedEx over the last 18-years. Mike was named CFO in March of 2020, and I’m grateful for his leadership over the three years since then as we navigated a global pandemic and significant change. Due to his tireless work, FedEx is on solid footing as we execute the next phase of our strategy. Above all, Mike has been a good friend and a colleague of mine, and I wish him all the very best. Now let me turn to my remarks for the quarter. Thanks to the hard work of the FedEx team, we have demonstrated continued progress on our journey to transform into the world’s most flexible, efficient, and intelligent network.

In the fourth quarter, we introduced and began preparing for one FedEx. At the same time, we continued to bend the cost curve through our DRIVE initiatives. This supported our fiscal year 2023 earnings, which came in above the midpoint of our March outlook, despite continued soft demand and an unplanned year-end tax expense, which negatively impacted our earnings by $0.18 for the quarter. Our operating performance remains solid. We’re entering fiscal 2024 with a continued focus on areas within our control and a commitment to execute swiftly on our priorities. This focus will support sustained profit improvement in FY ‘24 through an environment that we expect to remain marked by demand challenges, particularly in the first-half. Turning to slide six, I will start with a snapshot of the quarter.

Total revenue in the fourth quarter was down 10% year-over-year as volumes declined with demand remaining soft across the market. With this said, the rate of volume decline in Ground and Express improved sequentially. As expected, yield trends have been pressured in international markets where the supply demand balances have changed. We continue to maintain our focus on revenue quality and are committed to our disciplined pricing approach focused on the long-term. While we expect these pressures to persist, we do expect moderation throughout the fiscal year. With our execution, on a number of cost actions, we delivered adjusted operating profit of $1.8 billion. Our fourth quarter performance enabled us to close out the year with an adjusted operating margin of 6% and adjusted earnings per share of $14.96.

While our revenue declines were in line with the industry, I’m pleased to note that our flow through performance continues to improve, and we believe is the best in the industry in the first quarter of calendar year. Beyond the headline numbers, our results this quarter embed continued progress on our transformation. I’m pleased to see our cost out efforts take hold, but I’m also equally excited about the operational improvements we are driving as we build the smartest logistics network in the world. For example, our market leading picture proof of delivery is now available to 90% of global residential deliveries, having launched in Europe earlier this month. Picture proof of delivery gives our customers visibility to their delivered shipment at the click of a button and it has led to a 14% reduction in disputed delivery cases and contributed to a 17% reduction in call volume in the United States.

Our four hour estimated delivery time window which we have rolled out to 47 countries is also improving the customer experience. And at Ground, our dock modernization efforts are enhancing productivity, helping us run our dock smarter with new technology and key data insights. This includes a new network operating plan that uses machine learning to develop more detailed and accurate volume forecast. Ground remained a standout in this quarter as the team delivered operating income of over $1 billion. For the first time in company history, the Ground team expanded margins despite lower volumes in the second-half. This is a clear indication our drive transformation is working and gives us confidence as we push forward. And amid continued volume pressure, cost per package this quarter increased only 1.9%.

This was supported by a total reduction in operating expenses of $350 million as the company continued to manage staffing levels effectively, benefited from stock closures and consolidations and reduced Sunday operations. These actions help bring Ground’s fourth quarter operating margin to 12.1%. At Express, we have made significant progress aligning costs with underlying demand. Our initiatives continue to ramp and we expect accelerating benefits in the upcoming fiscal year. Demand dynamics combined with yield pressure drove a 13% decline in revenue at Express. This performance was generally in line with our expectations coming into the quarter. In the phase of these headwinds, the Express team was able to accelerate cost and productivity efforts driven by a combination of structural and volume-related initiatives.

The Express team reduced total flight hours by 12% year-over-year and permanently retired 18 aircraft, including 12 MD-11s this quarter. The team is also planning to take another 29 aircraft out of schedule flying in fiscal 2024. In addition, we made excellent progress implementing structural cost savings initiatives beyond flights, including certain domestic efficiency initiatives. This includes the shift to a single daily dispatch of couriers, which achieved its target of [$15] (ph) million in fourth quarter savings, as well as accelerated hub productivity measures. In Europe, we continue to improve operational execution across the region. Notably, we announced the official opening of two of our hubs this quarter. In April, we reopened our international road hub in Duiven, Netherlands and this month, we opened our new state-of-the-art road hub in Novara, Italy.

These two facilities have enhanced their capabilities, enabled more efficient routing, and improved our service on the continent. In aggregate, total operating expenses at Express were down $1.1 billion in the quarter. The magnitude of the operating margin decline has continued to narrow sequentially as our initiatives take hold. At Freight, the team is focused on maintaining pricing discipline, while flexing costs to protect profitability. The Freight team was able to reduce operating expenses by over $330 million in the fourth quarter. This will be further supported by our announced plan to close and consolidate 29 locations, which will be completed by August. Consolidation will improve service levels, while lowering our cost to serve. Further, we have conducted another round of furloughs to match staffing with volume levels and are limiting, hiring of salaried employees.

Turning to slide seven. We continue to make significant progress in taking cost out of our network, delivering a $2 billion year-over-year reduction in operating cost in the fourth quarter of FY ’23. This included more effectively matching flying with demand, marking the first quarter of this year where our flight hours declined more than the underlying volumes. Additionally, we continue to aggressively manage headcount, including attrition to align our teams with the network changes underway. We exceeded our target with U.S. headcount down by about 29,000 in FY ‘23. Also included in these cost reductions are ramping benefits from the numerous initiatives we have identified across the 14 DRIVE domains. Given our progress, we are confident that we can deliver on our previous goal for about $1.8 billion in cost reduction benefits from DRIVE this fiscal year and $4 billion of permanent cost reductions in fiscal year 2025.

As we introduced in April, between now and June of 2024, we will be consolidating our operating companies into one unified organization. One FedEx is the next step of this journey to realize our full value potential. It aligns our organization to one corporate structure that will facilitate the execution of our DRIVE transformation and will further enable the work that’s underway in Network 2.0. Our work towards this goal is already taking shape. We have taken a significant step forward in the implementation of Network 2.0 with today’s announcement of the transformation of our Canadian operations. In April of 2024, we will begin to transition all FedEx Ground operations and personnel in Canada to FedEx Express, creating a truly integrated and unified Canadian network.

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This unification is enabled by the nature of the Canadian market where the population is heavily concentrated in a few key geographies currently serviced by both OpCos. Consolidation will create significant efficiencies throughout the business from first to last mile and across our support teams. We expect this change in Canada to generate an annualized benefit of over $100 million upon completion in FY ‘25. We’ve announced transitions in 20 markets and Canada marks the first large scale implementation of Network 2.0, which builds up the learnings from our completed transitions in other geographies. To be clear, we’re not taking a one size fits all approach to our Network 2.0 strategy. Success depends on a mix of models including employees, and contracting with service providers as all are important pieces of how FedEx moves packages.

Looking ahead to FY ’24, we’re entering the year with a clear focus on what is within our control in an underlying environment that remains dynamic across geographies. This backdrop is likely to pressure revenue growth particularly in the near-term. As a result we’re taking a prudent approach to our full-year outlook that builds upon our solid finish to FY ‘23. We’ll also make progress on reducing capital intensity by continuing to focus on the highest return opportunities in an efficient manner. After FY ‘25, we have no additional firm commitments on Jet Aircraft CapEx. As such, we expect our aircraft related CapEx to decrease after FY ‘24 and be approximately $1 billion in FY ’26. This capital allocation strategy represents our approach to a more efficient and nimble network.

We will continue to look for additional opportunities as we proceed with our aircraft modernization strategy. We’ll bring this discipline along with our improved flexibility and agility to ensure that we are successful given the uncertain external environment. In closing, I’m confident that the progress we are making on our transformation will translate into improved margins, returns and cash flow throughout the year. At the same time, our commitment to driving operational improvement will further enhance the customer experience. Now let me turn it over to our Chief Customer Officer, Brie Carere, who will discuss market trends and our commercial strategy in more detail.

Brie Carere: Thank you, Raj, and good afternoon, everyone. As expected, the fourth quarter operating environment remained pressured with year-over-year volume declines in sequential moderation in yields across all transportation segments. We remain focused on revenue quality and creating meaningful differentiation while managing through these dynamics. Let’s take each segment in turn now. At FedEx Ground fourth quarter revenue was down 2% year-over-year, driven by a 6% decline in volume, partially offset by a 5% increase in yield due to surcharges and product mix. We once again delivered strong service levels and best-in-class market transits. Revenue at FedEx Express was down 13% year-over-year. Parcel volume declines were most pronounced in the United States.

And in addition, U.S. freight pounds were down over 25% due to a change in strategy from a very large customer. International export volumes were about 4% lower year-over-year. At FedEx Freight revenue was down 18%, driven by an 18% decline in volumes with revenue per shipment flat. This decline was driven primarily the slowdown in the market and high inventory levels. Although the pricing environment is moderating, our pricing discipline remains strong. Let’s move now to slide 11. As expected, yield was pressured as year-over-year fuel surcharge comparisons normalized. Customer demand rebalanced between priority and economy services with capacity availability. This is most notable on the Asian markets. In response, we remain focused on revenue quality, while managing our mix.

At Ground and U.S. Domestic Express, yield improved year-over-year, but at a moderating rate versus the previous three quarters. And as I mentioned a moment ago, freight at yield — freight yield was flat. Turning now to slide 12. Our efforts to make the network the most flexible, efficient, and intelligent network in the world are taking hold. We are delivering better service and outcomes for our customers, creating deep relationships and, of course, incremental revenue for FedEx. These efforts are supported by a fantastic portfolio of services. Raj spoke earlier about the benefits we and our customers are seeing from the expanded rollout of picture proof of delivery and continued enhancements to the estimated time delivery window. Later this year, we plan to narrow our four hour delivery window in many locations and provide new enhanced mapping capabilities to help customers track their package movements.

Return is also an area where we’re underpenetrated, and so we’re focusing on growth. Returns move through our network similarly to B2B shipments and are highly efficient in our network. In the fourth quarter, we introduced our new returns program, FedEx consolidated returns, which is available at FedEx office location. For merchants, it’s a low cost e-commerce solution for lightweight apparel returns with end-to-end visibility. And for shoppers, it’s a convenient, no label, no box drop off experience using a QR code. We have received excellent feedback and look forward to continuing to scale this solution very quickly. Finally, last month, we launched FedEx Sustainability Insights, a cloud-based tool that enables customers to view estimated carbon emissions for both individual tracking numbers and all their FedEx accounts.

This platform marks the foundation of a new suite of tools for our customers. It enables customers to transfer their carbon data to their own internal systems via an API. The insights are also available online for our small customers. Leveraging the vast shipment data that we have and using our AI machine learning capabilities, we are able to provide information to our customers in a meaningful and actionable manner. I am very excited about these portfolio expansions and firmly believe that a supply chain powered by FedEx is a competitive advantage for our customers. I’m proud of the team for their unwavering commitment to service and for delivering these innovative solutions. Now, I will turn it over to Mike to discuss the financials in more detail.

Mike Lenz: Thanks, Brie. I’ll start on slide 14. The FedEx team demonstrated strong operational execution to close out fiscal 2023. Looking at our transportation segment performance for the fourth quarter, starting with Ground, which continues to deliver strong results. Operating income increased 18% and operating margin expanded 210 basis points to 12.1% even with volumes down 6%. Margin expansion was supported by yield growth of 5% and strong cost controls driven by lower line haul expense. At Express, we’re seeing sequential operating margin improvement as our team continues to move with urgency to drive structural and volume related cost improvements. Adjusted operating income declined 47% and adjusted margin contracted 320 basis points to 5% as package volumes were down 7% and yields declined 3%, due to international package yield pressure.

At Freight, the team continues to navigate a softening volume environment. Operating income decreased 26% and operating margin declined 210 basis points as shipments declined 18% and yield moderated. Our fourth quarter results include several non-cash items. We recorded an impairment charge of $70 million related to the decision to permanently retire from service 18 aircraft and 34 related engines. The results also include $47 million of goodwill and other asset impairment charges related to the ShopRunner acquisition. In addition, we incurred an unplanned tax expense of $46 million from a revaluation of certain foreign tax assets. To provide additional color on recent demand trends and what we are planning for in our outlook, slide 15 shows trailing monthly volume trends over the last six months for our major service categories.

Volume declines continued in the quarter, while still negative, Ground in U.S. Domestic Express year-over-year package volume trends improved into May on a sequential basis. As we look to the first quarter of FY ‘24, we expect volume declines to continue to moderate at Express and Ground as we lap the onset of softer volumes, while freight will continue to experience pressure. This brings me to our FY ‘24 earnings outlook on slide 16. We remain acutely focused on maintaining our strong commercial position, prioritizing revenue quality, and driving profitability improvement through our efficiency initiatives supported by DRIVE. These efforts are more effectively aligning our cost base with demand, reducing our permanent costs, and increasing the flexibility of our network.

We do expect external business conditions to remain challenging near-term and they remains significant uncertainty with respect to the timing of demand recovery, particularly in the back half of our fiscal year. As a result, we are preparing for several potential outcomes as we think about the year ahead. This led us to establish an adjusted earnings per share outlook range of $16.50 to $18.50 for fiscal 2024. In a demand environment, it remains consistent with what we are currently experiencing, we anticipate flattish revenue for the full-year and full-year adjusted earnings per share toward the low-end of the range. Should macroeconomic conditions support an improving demand environment in the back half of the year? We expect to see modest volume improvement for the year.

In this scenario, we expect revenue to be up low-single-digit percentage for the full-year. This would also translate into greater operating leverage from our more efficient network on a higher revenue base, driving an outlook for full-year adjusted earnings per share closer to the high-end of our range. The key external factors that we’ll determine the FY ’24 outcome are broader economic activity in North America, Europe and in Transpacific trade, inventory restocking, and the development of e-commerce activity as we continue to differentiate our offering. At Express and Ground, we expect to build on fourth quarter cost momentum and see adjusted margin improvement in FY ‘24. Freight margins will remain strong in FY ‘24, but lower than FY ‘23 given significant volume reductions and yield pressure.

Turning to other aspects of our outlook. First, we expect a $230 million net non-cash pension headwind with a $330 million headwind below the line, offset by a $100 million lower pension service costs. Partially offsetting this below the line impact, we expect higher interest income on our cash balances. Our projection for the full-year effects of tax rate is approximately 25% prior to the mark-to-market retirement plan adjustment. We are projecting $500 million of business optimization cost at FY ‘24 associated with our transformation. We still expect a total pretax spend of $2 billion through FY ‘25 and the timing and amount of these business optimization expenses may change as we revise and implement our plans. Moving to the next slide, we want to share how we’re thinking about the operating profit considerations embedded in our expectations for the full-year.

For illustrative purposes, I use adjusted EPS of $17.50, the midpoint of the outlook range. This scenario is based on modest demand recovery leading to limited coverage of base cost inflationary pressures. In addition, we expect approximately $800 million of international export yield pressure as peak surcharges significantly diminish and product mix continue shifting toward deferred offerings. We also include a $500 million increase in variable compensation to ensure our compensation package is competitive. This is critical to retain key talent as we execute our DRIVE transformation. Importantly though, these pressures are more than offset by the $1.8 billion in cost savings from DRIVE. Together, these illustrative components lead to FY ‘24 adjusted operating profit of approximately $6.2 billion at the midpoint of our outlook.

Moving to slide 18, we continue our unwavering focus on efficient and responsible capital allocation in our pursuit to drive shareholder returns. For the year, we ended with $6.8 billion in cash in line with where we began the year, despite the challenging business environment. We accomplished this through continued improvement in cash conversion cycles and net working capital along with reduced capital expenditures. Capital expenditures were $6.2 billion which represented 6.8% of revenue, versus 7.2% of revenue in fiscal 2022. FY ’23 CapEx was slightly higher than our projection due largely to timing, as easing supply chain constraints accelerate the delivery of equipment and other projects. With a slight acceleration of certain spend into FY ‘23, we are now projecting $5.7 billion in CapEx for FY ‘24, which achieves our target of less than 6.5% CapEx as a percentage revenue a year earlier than we projected.

Our fiscal 2023 adjusted free cash flow of $3.5 billion supported the repurchase of approximately $1.5 billion in stock at an average share price of approximately $163 a share and we paid $1.2 billion of dividends. In addition, we funded $800 million in voluntary pension contributions. Looking ahead, we will continue to invest and attractive return improvement initiatives. We’re committed to further reducing capital intensity. Capacity investments at Ground will decline in addition to the lower aircraft expenditures expressed Raj mentioned. And we expect to repurchase an addition of $2 billion stock in fiscal 2024. As previously announced, we are raising our dividend by 10%, which increases our adjusted payout ratio to over 30%. These significant stockholder returns reflect confidence in our continued execution of profitability and return improvement initiatives.

Lastly, we are planning for $800 million of voluntary pension contributions to our U.S. plans, which were 94.5% funded at year-end. In closing, we are making progress on our transformation and remain focused on delivering shareholder value by driving improved profitability, lowering our capital intensity, while continuing to deliver strong return of excess cash to shareholders. And with that, let’s open it up for questions.

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Q&A Session

Operator: Thank you. We will now begin the question-and-answer session. [Operator Instructions] And the first question will come from Allison Poliniak-Cusic with Wells Fargo. Please go ahead.

Allison Poliniak-Cusic: Hi, good evening. Just want to go back to the optimization in Canada. I know you talked a little bit about the uniqueness of the region. Could you maybe talk to how does that impact the deployment of the optimization? And then more importantly, relative to say the U.S., how is the scale different in Canada versus U.S. and how that deployment would go forward? Thank you.

Raj Subramaniam: Yes, Allison, thank you for your question. Of course, Canada is a unique market and we’re taking a different approach there than the market-by-market approach we take in the U.S. The Canadian population is heavily concentrated in a few key geographies and the volume is split roughly 50-50 between Express and Ground. So we made the decision to consolidate everything under Express and is the right time to take these steps, because will begin in April 2024 and complete by September of 2024. And it’s very important that you understand that this is unique to Canada, because we are going to take a market-by-market approach in the United States and we’d have a hybrid in the United States between couriers and package handlers. But it’s a very important step for us in Canada, it reduces our cost by about $100 million and importantly improves our portfolio and service differentiation. Thanks for the question, Allison.

Operator: The next question will come from Jordan Alliger with Goldman Sachs. Please go ahead.

Jordan Alliger: Yes, hi, thanks. You sort of gave some parameters for the EPS range, $16.50 to $18.50, and mentioned in the second-half, what it would mean if the macro, sort of, accelerated in terms of the revenue side, but I’m sort of curious, as you think about the first-half of the fiscal year and the second-half of the year, as a way to give a sense maybe at the midpoint, the proportion of EBIT in both halves, because I suspect that it’s more of a second-half acceleration with the costs in the economy? Thanks.

Mike Lenz: Sure, Jordan, this is Mike. So let me break that down to a couple of elements. First, the demand projection we’re talking about for the second-half of the year would be relative to what we have been currently experiencing, so that’s the degree of uncertainty there in terms of how that flows going to the back half of the year. In the front half of the year, keep in mind that the significant inflection that we saw last year was very late in the first quarter, with that most pronounced at Express. So, we will be lapping that for the first quarter, and in addition, the trail-off in Freight volume accelerate into the mid to upper teens later in the calendar year as well, but largely in the falls when that started, so you got to think about the first quarter considerations there as you put the whole year together and our modeling.

But in terms of the outlook overall, we’re not projecting any material inflection in the demand environment to get to that point there that you’ve referenced.

Operator: The next question will come from Jon Chappell with Evercore ISI. Please go ahead.

Jon Chappell: Thank you. Good afternoon. Mike, just sticking with you on slide 17, the $300 million of revenue, net of cost increases, is there any way to break down how much of that is volume versus price? And if it is more kind of price-driven, the $2.7 billion of variable cost that you took out this year, how much do you have added back in fiscal ’24?