FedEx Corporation (FDX) Earnings Call Transcript & Summary

All right. Great. Everybody, thanks for joining us. Sorry for the delay. Thanks for taking the time out of your schedules. I know it's always tough to stay late and stay for dinner, so truly appreciate everybody joining us. So good evening, everyone. Welcome to the start of our 31st Annual BofA Transportation, Airlines and Industrials Conference. This is the 23rd one that I've hosted. I am Ken Hoexter, BofA's airfreight and surface transportation and shipping or marine analyst. We kick off our event with dinner with FedEx, which has been a nice tradition for us to start the conference over the past dozen or so years. So really appreciate FedEx's joining us for much of that time. We're here along with John Dietrich, EVP and CFO. John's first time joining us at the conference, having been named CFO last August. Also joined by FedEx's IR team, including Jeni Hollander and Steve Hughes on the stage; Matt DeBerry in the audience. Jeni joined FedEx as VP of IR on March 1. Steve Hughes has been a part of the IR team for 25-plus years. We welcome FedEx for the tenth time in our years hosting the event. Steve, your sixth time here, so only 4 more times and you get the coveted 10-timer jacket, so thank you, and Matt and Jeni's first time here as well. So we've got a lot to unpack tonight with DRIVE, Network 2.0, Tricolor, new management team, new reporting structure with One FedEx and more. So with that, I know they've got a brief Reg FD intro. So Jeni, I'll turn it over to you. But while I do that, I'll turn it over to you to Reg FD, and let me just open up with the first question so John can just jump in. So just I'll turn it over to you for a few-minute intro overview. You hosted your first analyst conference in 10 years nearly a year ago. As I noted, a lot of change going on at FedEx. But as you answer kind of what's going on in the update, just throwing maybe 3 key takeaways we should leave with today. So with that, Jeni, I'll turn it over to you.

Thanks, Ken. Yes, so the obligatory disclaimer. Certain statements made today such as projections regarding future performance may be considered forward-looking statements. 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 today to the most directly comparable GAAP measures. And with that, I will pass it over to John.

Great. Thank you, all, Jeni, and Ken, thanks so much for this opportunity. And thank you all for your patience. I really apologize I was late. But it's great to be here. I'm really excited to be part of the FedEx story right now. As Ken, you mentioned, I've been with the company now for just over 9 months. And I couldn't be happier with my decision to come to the company. I mean, you touched on some of the significant initiatives we have going, our DRIVE initiative as we work towards Network 2.0. And something that's even more imminent is our June 1 pivot to One FedEx. So we're in the midst of all this, so a lot happening at the company. And so when you talk about what are some of the takeaways, the top 3, I guess, what I would tell you is DRIVE is real and it's working. Network 2.0 is going to be the future. And right now, we are really bucking the trend in the industry. If you look at our results, in an environment where we're down in terms of revenue, we're up year-over-year in terms of margin and op income, and that's a great story. I think we're the only one in the industry doing that right now, which really speaks to the benefits of DRIVE and the rigor behind it even in a depressed market.

Great. So I'm going to jump into some numbers right at the start, right, so we knock off the numerical portion of what everybody kind of wants to hear, right? So you reiterated your target for earnings of $17.25 to $18.25, which means fourth quarter, which are coming up on $4.84 to $5.84. That's a pretty big 20% earnings range as we close in on year-end. Thoughts on why such a big window as we close out the year, and what were you considering when you thought upside/downside in that range?

Sure. Well, first of all, I'd like to address the midpoint of the range, that's actually higher than when we came into the year back in June, what we reported. So we were excited throughout the year to be able to narrow the range to the extent we did. But also, we're able to take into account the environment we're in. It's an uncertain market, so we've been looking at those things within our control and some of the variables that may not necessarily be within our control as we kind of prudently approached our guidance. And when you look at the results, again, you may hear me say this a few times, but 3 quarters in a row with down revenue, with up op income and increased operating margin on a consolidated basis. So we just wanted to take a cautious approach in our guidance and are focused on delivering and finishing out the year strong.

Okay. And just to follow up on that, thoughts on what drives upside/downside? Is it just, are we talking just volumes at this point? Is there cost, delayed cost takeout? What's your thought on the upside?

Yes. I think we're well positioned if the market is more favorable than it is today. We were not counting on that. So if we see some bright spots in the market, I think we have some potential upside. And as I say that, I think given the steps we're taking now and the leverage we're generating by bringing it all together into One FedEx, I think that's going to continue to be true in the future. I think we're putting ourselves in a position to really capitalize on a stronger market, which we're simply not seeing right now.

Okay. Just to harp on that for a second, we look at from an industrial materials sector over in our research and listening to the consumer team, it seems like they're talking about kind of a deteriorating environment. I know you don't give intra-quarter updates, but is there something going on in the consumer that you're seeing in the backdrop that seems to be decelerating at this point?

I'm going to look to where we've been and what we've been keeping our eye on. In terms of industrial production, it was down year-over-year about 1.9%, and so we're not seeing much improvement, I guess, is what I would say. On the parcel side, we saw a little bit of calendar year fourth quarter improvement for the first time in a while. But we're watching it very closely. And as you say, I'm not in a position to kind of update our guidance. But I mean, you all see what's happening in the world today. It's a crazy world that we're living in. The market is, again, uncertain and we're just focusing on those things within our control.

Okay. Let's talk about a lot of those things in your control. Actually, I want to just talk about one maybe out of your control. Your peer, at the Analyst Day they hosted a little while ago, talked about 12 million average daily volume capacity surplus in the U.S. small package market, half of which resides at the post office. How do you view the current level of excess capacity at FedEx? And what's the normal run rate of excess capacity you would keep in the network at any given time?

Yes. I think a lot of that excess capacity, as you said, is with regard to the USPS and with regard to lightweight, which is really not our core business. So from our standpoint, I don't know that there's a new normal in terms of excess capacity. What I can say is we're doing everything in our control to rationalize our capacity with the volumes and the demand we're seeing across all our OpCos, and we'll continue to do that. I think the USPS situation will allow us to better adapt to a changing environment in the market because we will not be as wedded to the daytime operations under the Postal Service contract as it exists today.

Okay. We definitely want to hit on kind of how DRIVE and Tricolor initiatives fit in rightsizing the network, and we'll delve in to DRIVE, but in a big picture, is there a way you look at DRIVE and Tricolor as far as starting that rightsizing of the network?

Yes, I'm actually excited about Tricolor because it also taps into a market that I was familiar with from my prior experience. But Tricolor is all about aligning our network with the products and the demand environment that's out there. Purple-designed to really leverage the Priority Express product, largely parcel, and to focus on not only that parcel delivery but also to maximize density on our Purple tails. The Orange network is also on FedEx aircraft, but it's off-cycle and not in the express hours of the night but more during daytime operations where we can take the time to gather the freight and focus on Priority International freight. That's kind of, what I'll say, parlayed with parcel add-on to maximize our density on the Orange network. And then the White network is really our belly capacity that's focused on things like e-commerce and deferred freight that will lend itself to more point-to-point operations, leveraging the significant belly capacity that's out there into main markets where we can off-load from the bellies and integrate it into our ground network here in the U.S.

Wonderful. We'll definitely dig into some more of that because it's really interesting stuff. But I want to jump to One FedEx, right, which is kind of your new reporting structure. I think yet, you will still get the same revenue and volume data as analysts, but no more Ground and Express divisional margins as far as I understand it, right? So some would voice skepticism that the loss of details, that we should be concerned. You would tell us don't be concerned because it's the ability to operate the company differently. So maybe tell us why One FedEx is an important step in how you look at the business?

Well, from my perspective, as you look at the consolidated operation, we're focused on doing the best by our customers and the best by our network. And sometimes that's trade-offs between the various factions of our operation and not to be overly focused in any one area but what's in the best interest of the business. And we believe all the consolidation that we're doing with regard to One FedEx, bringing Ground and Express together and also leveraging our significant LTL freight network, will allow us to do that. And that's a huge reason why we're moving forward in this direction. I also think we're going to provide enough data for you all to follow the various products. And we haven't announced specifically what our segment reporting will be, but we'll continue to provide information on yields and volumes so that you all can do the work that you do.

Okay. All right. Let's talk about DRIVE, let's start now with DRIVE because that's what's the current program. So you're in the midst of $4 billion DRIVE program, got $1.8 billion this year, $2.2 billion next year. Maybe just walk us through the quarterly that you've done so far and then whether we should see that accelerate. Well, I guess we have to see it accelerate if you've got bigger numbers into next year.

Yes. Roughly in Q3, we were at $550 million that we announced in terms of DRIVE results. Q2, that's somewhere in the neighbor of $450 million. And on the Ground side for Q1, it was the only thing we published about $130 million. So we're making very good progress, and I'm here to reaffirm that we are going to meet our $1.8 billion that we committed to the Street. Really excited about that. One of the things that attracted me to the company was to see where we are in this process, a tremendous amount of rigor. When we launched DRIVE, there's a significant investment in the processes and procedures that we were looking at and the integration we were looking at. When I came onboard, a lot of that heavy lifting had already been done, and we're in our execution phase right now, which ties into next year in FY '25. We have the $2.2 billion that we're looking to achieve. And that all is kind of a progression of some of the programs that are already in place, that are going to get more and more traction full year and other new programs that, for example, a lot of our G&A and procurement are kind of back-end loaded. So we're excited about going after that $2.2 billion in FY '25.

So I think that $2.2 billion has a lot of debate around it, right? Because now you've got the loss of the Postal Service contract. You've got other things that are countering the $2.2 billion. Is there a number that you can talk to? Or walk us through how we should think about what of that $2.2 billion can fall through down to the bottom line.

Well, you're certainly right. There are a lot of factors that are causing some of that not to flow through. I mean, we have a depressed demand environment. Yields are softening, or have softened, I should say that. Some of the demand surcharges that we had enjoyed before are no longer in play, and we shouldn't see as much of a headwind on that in FY '25. The Postal Service, you're right, that's a headwind as well. And then you'll recall, as we reported, there was roughly $800 million of shift in mix from Priority to Economy that also was a headwind for us. So it's not all going to flow through, but we are focused on having as much, I think I said this on our last earnings call, of that flow through as possible. I'm not going to give you a number. I can't give you a number right now. But what I can tell you is we're focused on it, and I look forward to giving you all an update on FY '25 in June.

But the goal would be to see still you're countering the increased cost or loss of Postal business or whatever with some of that $2.2 billion continuing to flow through, it's just a question of how much.

So what I can tell you is that the $2.2 billion, when we talk about that and we talk about the $1.8 billion, is structural in nature and not kind of variable or yield-driven. These are structural changes that we're making to deliver on that. Is all of it going to flow through in FY '25? I can't sit here and say that. What I can say is my goal is to see as much of that flow-through as possible.

Can you maybe remind the audience a little bit about the breakdown of DRIVE in terms of, we did it by year, right, now maybe by sector, air, how we should think about what's going on in Europe, what's going on in G&A, what's going on in service transportation? Are there buckets that we can start to think about?

So the 3 main buckets are Air and International, Ground Surface and G&A. And on the Air and International, $1.3 billion, made up of $700 million of Air and $600 million in Europe. And then Steve, keep me honest here on the Ground and Surface, on the $1.2 billion.

$1.2 billion, that's transportation; and $1.5 billion, G&A.

And $1.5 billion in G&A, yes.

And then of that, maybe just take a deeper dive in Europe, right, because we all watched you acquire TNT, integration of TNT, elimination of the second air network. Like, how should we think about those savings flowing?

Yes. Look, Europe is a real opportunity for us. We're taking a fresh look not only kind of the prior implementation and integration plans with TNT, which existed before I arrived, but now I think there's even more opportunity to look at every aspect of what we're doing in Europe. G&A for sure, is going to be part of it. Using some of the lessons we've learned in DRIVE in the U.S. on our Ground, with a focus on Surface first before the Air network, making some changes to our Air network, fly only when we need to fly, I think there's going to be more and more opportunity. Again, I can't sit here and say how much of it's going to flow through, what I can say is we're focused on the $600 million, for sure, and whatever more we can get.

Does Europe become profitable after that?

Our focus is on making Europe profitable. When that happens, we're going to keep focused on that.

Let's turn from DRIVE to Tricolor, which is part of DRIVE, right? So if I think about the better asset utilization you're talking about, maybe take what you broke down, Purple, Orange, White, into categories. Maybe talk about how we should see that or maybe just give an example or two of some programs that Tricolor is bringing about.

Yes. As I alluded to before, I think there is a significant market that's there that we're not really participating in, that's there for the taking in terms of priority freight and leveraging the significant assets we have internationally and the ground network that we have domestically to make Tricolor attractive. We're not going to see huge results in Tricolor certainly this year. We'll see some benefits in the next year, so there's going to be some lead time to get it fully up and running. There's some investment we're making in terms of some of the White belly capacity. There's some procurement that needs to take place in order to secure those agreements with the various international carriers. But I'm excited about what the prospects are of that coming together. And again, as you said, our goal is to fully utilize our assets as best we can, focusing on the right assets for the right product, the right levels of utilization and increased density.

So I'm just so used to talking about when I talk about Europe and TNT that everybody understands what -- how many people remembered TNT being around as an independent? I mean, it's amazing how quick it fades, right, that it's not a legacy thing. So I want to stick on Europe for 1 more second. In fiscal '25, European net savings, as you rationalize sorts, optimize linehaul, the stuff you were talking about doing, I think that you also threw out $1 billion of G&A savings. Is that domestic G&A savings? Is that global? Maybe you could give some examples of what's going on in the savings.

Yes, it's global. It's across the board. So everything on the procurement side, roughly $600 million of that is procurement, IT. We have some great opportunities in IT. And as part of our plans going forward, this doesn't all just happen. This is going to involve a significant amount of investment in IT and the digital initiatives that we have. We're excited about the new leadership team that's been announced. Some seasoned veteran personnel that are going to come along in conjunction with not only IT but our DataWorks subsidiary. So we're really excited about the IT piece. So those are some of the major components.

And I'm going to jump around here on my questions, but the IT systems, I want to get to Network 2.0 in a bit, but are the systems the same? Or I understand they're different, right, Ground and Express, so how much of that expenditure needs to be accomplished first before you can move and blend the networks?

Yes. And it's one of the legacies of operating separately for so long. We've had the separate OpCos, and the systems are not always the same. Some are, and over time, we've integrated some systems, but there is going to require some investment in integrating systems and kind of having some common platforms which, on the one hand, is daunting; on the other hand, is very exciting because of the opportunity it creates for us. And it's really one of the reasons why, when we're talking about things like Network 2.0, we've given ourselves some time to work towards that. We're going to be keeping our finger on the pulse to make sure with the initiatives that we are implementing and the systems we are changing that they're sufficiently tested and proof-tested such that we're not going to, in any way, jeopardize or harm the customer or our operations. So it's a joint team effort, really exciting. The work that's being done, the talent that we're able to recruit, it's something I look forward to briefing you all further on as we make progress.

Certainly interesting stages ahead. Within Express, let's go back to the kind of the macro view we were talking about. U.S. package volumes have been negative for 10 consecutive quarters. We're lapping 2-year stack of volumes down 20%-plus. Anything to suggest we're starting to see some positive comps? Anything, economic view or we're seeing port volumes picking up? Is there e-commerce demand that's turning anything that you see that shifts that comp?

Yes. It's really a bit of a tale of two cities. On the e-commerce side, we've seen a return of e-commerce and growth in e-commerce, actually. There's this whole discussion on destocking, which we believe has taken place, but we haven't seen the restocking yet, so I think that gives us some potential upside. I talked about industrial production as somewhat depressed. There could be some potential upside there. And I also mentioned calendar year '23, the fourth quarter, we did see some signs of improvement but we're watching it closely. And look, Express continue to be an opportunity for us. And even without the market improving for us, we're going to continue to focus on those things within our control. Tricolor is a piece of that. Some of the network redesign is going to be a piece of that. All of the DRIVE initiatives are focused on improving Express and the consolidated operation as well.

All right. We'll definitely get to some margin discussion, too. Pricing, following that volume discussion, I guess the one thing we've talked about this sector, I think the last few years, which has been really a big positive, is your willingness to allow business to fall away, right? We started with Amazon. Was that 2019? Was that in 2019?

2019, yes.

The post office more recently, right, in terms of how would you describe the pricing environment in this backdrop?

I would describe it as competitive but rational. It's one of our biggest competitors is going after business, and we're going after business as well. And I'd say it's back to kind of a normal pricing environment in a competitive market.

Okay. So you've targeted Express margins to be down year-over-year from 5% a year ago but up sequentially from 2.5% in third quarter. So we're still talking, I think in the backdrop, pretty low margins at this segment, which was half the company's revenues, 47% of the company's revenues. Why do we still see margins at this level? I guess that's why you've embarked on DRIVE and Tricolor. But are you still surprised at the margins being stuck at this level versus some of the programs you're putting in place?

Well, as I just said, I think there's some opportunity at Express. It's a primary focus of ours. You have to also take into account all the headwinds that Express has endured. I talked about the falling away of a lot of the demand surcharges, the significant shift from Priority to Economy and deferred product. And those kind of variables put a tremendous amount of pressure on Express. The drag from the U.S. Postal Service business that we said was about $400 million for FY '24. All those things were hitting Express. And when you have such a large network and want to continue to serve your customers, which we do, it takes time to adapt to that environment. And we're focused on it and we look forward to continuing to expand the margins.

Awesome. Within Ground, let's switch over to Ground for a bit, starting with volumes. Virtually, again, no growth as Economy and Ground commercial have offset home delivery declines. Just a statement of the economy. Or is there a share shift intra-segment, intra-industry, in there? And maybe talk a little bit about your SMB focus versus enterprise focus within that.

Yes. I think Ground is a great example of how DRIVE is really working. We've done a lot of work to maximize the efficiency of Ground. We've been able to capitalize and bring our total linehaul costs down and absorb some of them, what was previously ad hoc line haul expense into our network, which is all part of DRIVE and the technologies that we're implementing in DRIVE. And the demand environment, we're going to continue to go after some of the things you talked about: SMB business as well as health care and some of the higher-yielding ground traffic. So I'm excited about to programs that are in place at Ground and also the role it's going to play as we move towards One FedEx. Still a lot of work to do, Network 2.0, it's going to take some more time but some great work going on there.

UPS talks a lot about adding on health care SMBs. Does mix matter? Is there a difference of what you're doing behind the scenes in terms of chasing end market business?

Well, we're focused on revenue quality. FedEx has an outstanding service offering, I dare say superior in terms of speed and reliability, and that's been one of our strengths. And we're able to garner a strong yield as a result of that. And we're going to go after these markets, and I think we're going to be successful as we go forward. And so mix is always a factor. But our focus is on because of the product and the network that we have, we think we can compete for the highest-yielding freight.

So on that, we used to hear a lot about UPS and FedEx kind of talk about what percent of lanes they were faster than the other. Is there a catch-up from your peer on service capability where we don't hear each of the companies talking about that? Or you just mentioned superior services there.

I'm just going to talk about our network. I mean, if you look across the board, we have speed, we have reliability, and we think we're the best at it. And we're going to continue to prove that to our customers.

So on Ground, sticking on Ground, you target margins up year-over-year and up sequentially. Anything different seasonality-wise or market shift given the lack of volumes that you'd highlight onto your last target there?