Levered for success, FedEx sends shockwaves through the market

Key Points

• FedEx had a weaker-than-expected quarter and lowered guidance, a trend likely to continue in FQ3.
• Operational improvements were not enough to offset economic weakness but set it up with leverage for the rebound. 
• Cash flow and capital returns remain strong, but dividend increases may slow drastically this year. 

FedEx Corporation NYSE: FDX executes well and builds earnings leverage. The bad news is that business continues to weaken, impacting the overall top and bottom-line results and the economic outlook. This situation has the market for FDX shares moving sharply lower following the FQ2 results, paving the way for a buying opportunity for investors. Eventually, the economy will turn, and this company will be a cash-generating powerhouse. 

However, there may be a better time to buy because weak results compound the second consecutive quarter of weak guidance. Based on the latest read, FedEx investors should expect the Q3 results to echo the Q2, including another downward revision to guidance. Competitor United Parcel Service Inc. NYSE: UPS has lowered its guidance for several consecutive quarters and should not show strength now. In this environment, it is more likely this stock will continue lower in the near term before it puts in its bottom and sets up for the rebound. 

FedEx widens margin to DRIVE solid cash flow

FedEx's top and bottom-line results are weaker than expected but offset by sequential and year-over-year (YOY) improvement in the margin. The company's DRIVE program focuses on service to enhance revenue quality and is working. Investments in modernization, including a lean into automation, AI and efficiency, led to a double-digit increase in adjusted operated income, with $1.8 billion in cost savings expected to stick. Regardless, the $22.2 billion net revenue is down 2.6% compared to last year and missed the consensus by 100 basis points.

The margin news could be better. The company delivered margin improvement but less than expected. Although the adjusted operating income increased by 17%, it was insufficient to meet the consensus estimate tracked by Marketbeat.com. The $3.99 in earnings is solid and leaves the outlook for the year and capital returns unchanged, but missed the target by 21 cents, or about 500 basis points. 

The only good news is that guidance, with revenue forecasts reduced, includes an earnings outlook with consensus at the low end. However, the company may not meet this goal because of persistent weakness in demand. Once the holiday is over, demand could fall off a cliff.

FedEx capital returns on track 

FedEx results were less than expected but still robust in the cash-generating department. The company generated over $1 billion in net income, allowing for reinvestment in modernization, dividends and share repurchases while maintaining a solid balance sheet. The company completed $500 million in accelerated repurchases during Q2, with YTD repurchases impacting earnings by a nickel. The company plans to repurchase another $1 billion by year-end, or about 1.5% of the post-release market cap. 

The dividend is safe, so long-term holders can rest easy. The company's $5.04 payout is less than 30% of the annual guidance at the range's low end, leaving it well-covered even with weaker-than-forecast results. Distribution increases are also likely to continue, but the pace may slow and fall into the mid to low-single digits. 

The technical outlook: FedEx delivers a deep correction for the market

Shares of FedEx had been trending upward ahead of the release, but no longer. The post-release action has the market down 10%, confirming the top of a range that will likely cap this market for the foreseeable future. The risk now is a fall below the critical $250 level. A move below there could result in a multi-year downtrend for the transportation sector, with a bottom reached sometime in 2025.