The new chief executive of FedEx, Raj Subramaniam, is off to a rough start. Late Thursday, he warned of a worldwide recession as inflation ravages consumers’ buying power, central banks jack up interest rates to subdue overheated demand and China’s policy to stamp out every case of COVID-19 becomes more of a self-inflicted wound on production. The company made the unusual decision to pre-announce earnings well below consensus estimates and pull its annual financial guidance, which it had just provided in June.
Investors promptly shaved off more than a fifth of the company’s market capitalization. Before the market goes into a prolonged panic based on FedEx’s pronouncements, though, it would be prudent to check with United Parcel Service and Deutsche Post’s DHL unit to see whether they are experiencing the same sudden calamity.
There will be more details next week when FedEx reports fiscal first-quarter earnings on Thursday, but investors should keep in mind that FedEx has had serious operating issues since the pandemic hit and has a long history of getting its guidance wrong. On a weighting scale, this most likely leans more to a FedEx problem than a global economic one. Longtime investors have heard the promises and watched management not deliver too many times to take everything in FedEx’s surprise announcement at face value. In its fiscal year 2019, the last full year before the pandemic hit, the company set guidance, raised it and then cut it twice. The previous year, FedEx introduced an adjusted earnings target, lowered it and then raised it twice. In fact, in nine of the 10 years that FedEx has set an annual earnings-per-share goal for the entire year, the company has cut the target at least once.
Now, less than three months since Subramaniam stood in front of investors and analysts in an auditorium at FedEx’s Memphis headquarters and laid out ambitious long-term targets, the company is now saying it was caught off guard by sudden weakness in Europe and Asia. Let’s see: Russia’s war on Ukraine started in February. China’s Covid-zero policy already was becoming disruptive by March, and that’s the month the Federal Reserve began raising rates.
Even before the investor-day meeting, which was the first in a decade, Subramaniam had caved in to demands from activist investor D.E. Shaw just two weeks after he took over as CEO on June 1 from legendary FedEx founder Fred Smith. But instead of coming up with a bold plan to introduce structural changes or make FedEx more efficient, FedEx announced it was adding board members picked by D.E. Shaw, pumping up the dividend and reducing capital expenditures. Wall Street cheered, and the shares surged 14 percent in one day.
If D.E. Shaw would have spent more time peeking under the hood of FedEx’s operations instead of running models on how much shareholder returns could be squeezed from the company, the activist investor would have noticed some festering problems.
The most glaring difficulties are at FedEx’s Ground unit, which hires about 6,000 independent contractors to take packages from sorting facilities to the final customer. This business has been grappling with declining profit margins since 2012 and has been rife with inefficiencies, such as the clunky handoff of packages to contractors and the surging turnover of contractors’ drivers. The problems with the contractor model were magnified by the pandemic, which kicked off worker shortages and rising costs for fuel, maintenance and labor. The conditions for contractors deteriorated to the point that they began to organize to force FedEx to give them better terms. It is still unclear now how FedEx plans to resolve this dispute and whether a contractor revolt will hurt service during this year’s peak season that begins in November.
The company’s Express unit, which is the business that Smith founded in the 1970s and changed the package-delivery industry by introducing overnight deliveries, has never been very profitable. The company’s operating margins have been below 7 percent for the past five years and have averaged 5.7 percent since 2008. Express delivery is a capital-intensive business — it costs a lot of money to buy, fly and maintain large aircraft. The unit has depended on the continued growth of global trade, which likely has peaked and could be on the decline as companies seek to shorten their supply chains.
FedEx has an overarching structural problem of running two distinct networks. An Express driver, who is on FedEx’s payroll, can deliver a package to the same place that a driver working for a Ground contractor had just stopped. Some investors have clamored for the company to combine its two networks and emulate UPS, which cites its unified network as its core strength. This is becoming more evident as UPS’s margins rise and FedEx’s fall, but the company still defends its dual network system.
Investors were hoping that Subramaniam would take the reins and make real changes. It’s hard not to compare the new CEO with Carol Tome, who took over at UPS in June 2020 during the height of the pandemic and hit the ground running. She focused on efficiency and declared UPS would be “better, not bigger,’’ which meant taking the higher-value packages while not overtaxing UPS’s network with lower-yielding parcels or complicated large packages. Tome has made strategic acquisitions, such as the largest same-day package delivery company Roadie and a European health-care delivery company Bomi Group. FedEx is just now consolidating its disastrous 2016 acquisition of Europe’s TNT Express.
During a breakfast meeting with analysts on Sept. 6, UPS reaffirmed its guidance for 2022. The slide deck for the meeting said, “We are controlling what we can control and have confidence in our ability to achieve our full-year guidance, despite a dynamic macro environment.” The analysts’ notes that followed glowed over Tome’s new theme: “Moving from Better Not Bigger to … Better and Bolder.”
Subramaniam should take a page from Tome’s book and be willing to take a fresh look at how the company operates and to break with tradition. He should combine FedEx’s networks into one, not with contractors but with FedEx employees who are paid well and motivated to stay for decades, as is the case with UPS.