FedEx Corporation (FDX) Earnings Call Transcript & Summary

All right. Good afternoon, everyone. Welcome to the first afternoon session. My name is David Vernon, I cover transports and airlines at Bernstein. We are thrilled to have for the first time in my 10 or 15 years covering the company, FedEx is joining us at the SEC. We are in our quiet period. So they have a little bit of restrictions on some of the stuff they can talk about. We are going to get into some Q&A. I think what we're going to do here just so you guys know that you probably know the drill by now. We do have a digital app if you have questions, put them in there, and I can try to work them in through the iPad. If there are and then -- what we're going to do is have Jenny Hollander from IR come up and read a couple of forward-looking disclosures. And then Raj is going to kick us off with some prepared remarks, and then we'll get into the Q&A. So thanks again for attending the conference. Thanks to FedEx for attending, and I hand over to Jenny.

Thanks, David. 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 the filings with the SEC.

All right. With that, I think we'll let Raj kick us off with some prepared remarks.

Okay. Well, thank you, David, and thank you all. This is my first time to be at this conference and look forward to sharing some comments about FedEx, who we are, how we are transforming and where we are headed, and then we'll take questions after that. So firstly, I just want to talk to you all about the critical role of FedEx place in expanding global trade and to help build smarter supply chains and delivering products and services to customers around the world. I thought I'll start by giving you a few stats that illustrate the scale of our operation. We link more than 99% of the world's GDP. We delivered more than 15 million packages every single day. We reach over 220 countries and territories, including every single address in the U.S. We operate more than 5,000 facilities, 700 aircraft and more than 200,000 vehicles more than -- have more than 500,000 employees worldwide and generate 1 petabyte of data every single day. Now of course, we didn't achieve all this overnight. And over the course of 51 years is what has taken us to get here. Our service offering started with just 186 deliveries back in 1973, beginning with our Express our time-definite business, which is now the world's largest air cargo airline. We expanded into the ground or day-definite parcel business in the late '90s with our acquisition of Caliber Systems, which has now become FedEx Ground. And following the acquisition of American Freightways in 2001, we rounded out our offering [indiscernible] FedEx Freight, which is now the country's largest less-than-truckload or LTL carrier. Now as we have grown these businesses over time, our customers have embraced the bundled offering with nearly 80% of our U.S. revenue now coming from customers using Express, Ground and Freight services. The first point I want to really make now is that building networks is a hard and time-consuming work. And thanks to these networks, we can pick up a package or a pallet anywhere in the world and get it to any other part of the world in a very short time. People use the word networks all the time, but sometimes they don't really get it. When you use the telephone, you understand what our network is you can pick a phone call anyone. Similarly, when you have a global network, you pick it up from anywhere and deliver anywhere else. And that is an enormous moat that we have around us to be almost impossible to replicate. You try getting a square foot of space in the Paris airport or Shanghai or in Delhi or wherever, you know what I'm talking about. And with the unmatched global logistics networks, outstanding customer service and an iconic culture, driven by our people, we have built deep relationships with our customers, and we are extremely proud of the work we do. For example, we continue to deliver vaccines and critical health care equipment as we did throughout the pandemic. We transport key manufacturing inputs to keep the supply chains moving or even ensuring that the Lombardi Trophy makes it a Super Bowl in town. Since the turn of the century, we have grown our revenue at roughly 6% compound annual growth rate. This is true even including the demand volatility we saw during and after the pandemic. With our resilient networks, we manage this unprecedented COVID demand surge when our revenue grew at a roughly 15% compound annual rate for 2 years. And more recently, we have navigated the retraction in demand experienced across our industry. The market has evolved, and we are evolving our business with it. We saw this downturn come early, and embarked on a structural cost reduction program, and we are ensuring that we are well positioned to improve profitability irrespective of the demand environment. And we are ready to emerge as an even stronger company when demand inflects positively and we return to that normalized growth rate. And through these efforts, we are significantly improving the profitability of the company as we lower our cost to serve, enhance capital efficiency and better serve our customers with market-leading capabilities. We are in the early innings of our cost reduction efforts, but progress is already evident in our results. This includes margin expansion and earnings improvement over the past 3 consecutive quarters despite the declining revenue environment. The entire industry is feeling the revenue pressure, but we are unique in our ability to grow profit even in these market conditions. And this is a clear sign that our efforts are working. Our target is a combined $4 billion in cost reductions in fiscal year '24. By the way, our fiscal year '24 ends on Friday. And combine fiscal '24 and '25, which begins on Saturday. We are examining every aspect of our cost structure with a focus on our surface network, our air and international network and G&A. We shared at our Q3 results that we expect to deliver $1.8 billion in savings this fiscal year and another $2.2 billion in fiscal '25. When it comes to CapEx, FedEx is at an important inflection point. Our multiyear aircraft fleet modernization strategy positions us well as one of the youngest fleets in the industry. Our capital expenditure continues to decline as a percentage of revenue as we reduce capacity investment and plan for lower annual aircraft CapEx. This enables us to focus on returning cash to stockholders through share buybacks and dividends. Now let's talk about network transformation. And first, let me provide you a little bit of context of how we got here and more importantly, what -- where we're going. For many years, we ran our businesses with a strategy to compete collectively and operate independently, which served us quite well. For example, 25 years ago, we held a 10% share in the ground parcel market, 10% with a 70-point market share gap versus our primary competent. And thanks to our simpler and faster model paired with a stronger service, we grew market share every quarter for several years narrowing that gap to about 10 percentage points today, 70 point to 10 points gap. So you may ask the question, why change? Well, the most meaningful change in the market is the emergence of e-commerce. A vast majority of growth in the parcel market is now driven by e-commerce. A little less than 10 years ago, roughly 75% of the stocks, or packages stocks were businesses. What that means is we have a FedEx Express truck and a FedEx ground truck pulling up to a business just like this building perhaps delivering 6 time definite packages and 10 day-definite packages. At the same stop, and this approach made business sense because the rest of the network was fully optimized for time-definite and day-definite services, respectively. You fast forward to today, now about 75% of our stops again, our packages stops are residential. So you might see a FedEx Express truck drop off a package at your house, followed by a FedEx ground truck sometimes delivering another package later in the day. So now you can imagine the room for improved density and efficiency. So that brings me to our transformation and how we're changing the way -- we run our business to better align with market demand and operate more efficiently. And this is the reason why in April 2023, just over a year ago, we announced a multiyear strategy to unify our businesses and create the world's most flexible and efficient and intelligent network. And one important pillar of that transformation is what we call Network 2.0. It is the network of the future, where we are combining our Express and Ground networks in the U.S. and Canada. And the best way to think of Network 2.0 is 1 truck, 1 neighborhood. We spent the past several years updating our technology and facilities to prepare, and we are now in the execution phase. We have already implemented Network 2.0 in over 50 locations with dozens more to follow this calendar year. And as we have stated previously, we're targeting a $2 billion in cost savings in FY '27. Additionally, we are redesigning our global air network. We will improve the efficiency and asset utilization of the entire FedEx system to put the right product and the right network to drive density. Our work here will allow us to use our unique talent distribution capabilities worldwide to profitably target more of the premium airfreight segment. We will do this with a truck-fly-truck model, leveraging existing capacity in our trucking networks to move the international freight shipments. All our revenue growth initiatives, structural cost reductions and network transformation efforts are managed through a program that we call DRIVE. DRIVE is simply the way we work is characterized by rigor and discipline with a keen focus on business outcomes very quick decision-making time lines, especially for an organization of our size. So now that you have a glimpse of the major change underway at FedEx, let me share a few thoughts on our formula for future success. First, we are focused on return to profitable growth. This is growth in higher-margin segments like technology, health care and small and medium businesses. Second, we will continue to drive our structural cost improvements, lowering our cost to serve. We have made considerable progress here, but there's more value to unlock. As I shared previously, we expect to achieve $4 billion in savings in fiscal year '25 plus an additional $2 billion from Network 2.0 in FY '27. And third, we leverage the vast amount of data we access from the 15 million packages we deliver each day. We will create data-driven solutions that bring internal efficiencies and enable us to better serve our customers. These solutions really build a platform mindset of reusability and scalability with a mission to make supply chains smarter for everyone. Just think about this prior to the pandemic, if I had mentioned the world supply chain, I probably a politely exited out of the room. It was the preview of procurement managers, perhaps the CFO. But ever since the pandemic, supply chains have now risen to board-level conversations and you will hear even in talk shows these days. So this is the right time for us to make our mission to now become -- make our pricing smarter for everyone. We're already obviously a leading supply chain company with an unmatched global physical network. We moved more than $2 trillion worth of goods every year and we sit in the middle of an immensely powerful data ecosystem. Leveraging our physical network and our digital platform, we are on our way to becoming a leading supply chain technology company as well. So these 3 long-term strategic priorities are interconnected and create even more value when they are all mission together. I hope that you will take away from today's conversation my conviction that there's enormous opportunity ahead of FedEx, as we transform how we operate while continuing to offer our customers unmatched speed and service. Thank you for your attention here. We look forward to the Q&A. Thank you, David.

All right. Thank you very much for the overview, Raj. So I want to kind of structure our discussion in a couple of different areas. First, talking a little bit about some bigger market trends that you might be able to help shed light on core investors. Talk about some of the sector themes that are important and then maybe dig into some of the cost production trends and restructuring that you've got underway. Okay. So starting in the area of sort of big picture themes, You mentioned supply chain being at the forefront of many companies' minds. And it does feel like we're now in a world where there's always a supply chain crisis somewhere. How is FedEx positioned in the marketplace to capitalize on that? Or uniquely benefit from the increasing volatility that seems to be affecting the rule of supply chain?

Yes. So 100% agree with you that supply chain has now suddenly risen to the top of the list on several people's agendas. And if you go back in history, and especially in the last 35 years that I've been working at FedEx, that the supply chain perturbation have been you rather muted, even in like the global oil crisis or even in the 2008 financial crisis and so on and so forth. This is because of the physical systems like ours and the improvements in technology. So the perturbations were, of course, there were, but they were minimal. What we are now seeing the pandemic was -- is one giant change. And so the supply chain bullwhip effect that we are seeing right now. So from a FedEx perspective, we've -- if you go back like [indiscernible] sleep in 2020 and woke up today, we grew roughly 6% CAGR in the last 4 years. And it's comparable to the last 25 years, except the fact that there was a huge spike for 2 years and then a modest decline in the last year. So I think this is a unique period in the last 35 years. And so that's why you see some there's not multiple things happening. It's part of the same, still reverberating from the historic pandemic issue. So from a FedEx point of view, we get to see the signals early, and we're able to move faster. Our mission to make supply chain smarter for everyone is coming in from this idea that we simply have the data and more involved with the insights about the global supply chain every single day, especially the high-value goods of the economy. So today's supply chain trends is different than tomorrow and day after, I mean it's changing. And so -- and we are watching it very carefully. We are making sure that we use information to make sure our ground networks are very efficient, but we're also integrating with our customers to make sure that their supply chain could pick up. And in the age of e-commerce, make sure that the end consumer gets the value by getting increasing predictability and reliability. So that's how we are doing our physical and digital networks are now working together to make that happen.

Is it fair to say that volatility is actually helping from a revenue growth standpoint in terms of the demand angle? Or is it more episodic?

The volatility, as we think about the last 4 years, I mean, that's what we were 2 years of real steep increase in the demand and then 2 years a slight decline. I think we are all seeing as an industry now when that bottoms up, I think it will slowly gets back into a more normalized environment. But again, if you think back about the e-commerce as a penetrate percentage of retail, spike came back. So a lot of things have really come back to the original trend except for interest rates and inflation.

Right. And one of the other sort of supply chain megatrends you talked a lot about, frankly, a lot I think is bolt-on. Is this issue with near-shoring?

Yes.

And I want to ask a question to you in 2 ways around near-shoring, number one, are you seeing those shifts in sourcing? And are they tangible enough to actually impact your business?

Yes. The supply chain patterns are fundamentally changing, and you can see it. It's not just people to talk about a diversification into new markets, it's not just that. It's like a lot of the intermediate products were built in different countries, they made their way to China, for example, [indiscernible] then went to the final consumption point of U.S. and Europe. That pattern is now changing. And we can see different things are happening in that. So it is not only that new countries are coming into play, just the patterns of all goods are produced change. And the good news for FedEx is that we see it from the bottom up because practitioners in this business when a manufacturer wants to change any kind of thing in their supply chain, they need to make sure that the logistics is taking care of. So we hear about it first. And so we -- and the good news from FedEx point of view here again is that because of the network that we already have in place, nearly every single time that where you want to move, you already there. And it's just a matter of just connecting to that point. Even if it was a new point, as a matter of connecting that point to the nearest [indiscernible]. So we're -- we have an inherent advantage in that sense that we already have a network in place. Now to specifically, Mexico is an area where things are moving towards -- you can see it in Vietnam. You can see in Southeast Asia, you can see in India. And we'll see how these trends play out, but we see it, like I said, in the bottom up and we move fast the manufacturing...

So if you think about Mexico becoming more important than trying to sort of at the margin, does that pose a unique risk to you guys or [indiscernible] network because you probably don't need...

No, but we have -- I just observed Mexico, actually, we have a fantastic advantage FedEx in that sense because, if you think about the presence we have in Mexico and the ground-based networks that we have in the United States and you put the 2 together, we actually are in a very unique situation there because if you look at our competition, they're not that big in Mexico. If you look at DHL, they're not that big in the United States. And so it's -- we are actually in [indiscernible] in that perspective. And we have all the ground-based distribution models that we have in U.S. So no, I think that's actually -- like I said, it doesn't matter where it moves, you're already there.

But there's a greater challenge around the air assets?

No, we will size our air assets depending upon traffic. I think with today, Asia represents, I don't know, 40% of global manufacturing and I see that go down maybe a little bit, but -- so it's -- we will manage overall capacity based on the demand environment. That's not a problem.

Okay. And then if you want to talk a little bit about some of the sector themes. Obviously, the growth of e-commerce. You talked about the something that the -- we think we understand pretty well. But when you're talking to investors, we hear a lot about this idea that, hey, what moat -- Amazon just stood up a network with more trucks than FedEx Ground has, how is it -- what moat are you talking about?

When you talk about a moat, the business itself is fundamentally different because it's sort and deliver, not just deliver. So if you look at our FedEx facility packages come in and out, they move through it in minutes. When you look at a comparable e-tailer facility, they're going to stay there for days and weeks. It's a different business. They don't know. And so that's not even a comparable thing. So this idea of a network that's why specific, they said a network. Network is we have to pick up and deliver. And that's what we have uniquely have. And so there is a significant moat. The other part is that if you look at a FedEx truck delivering moving on the road, there's packages from all over the world. The revenue on that truck is significantly higher than just what you can pick up on local delivery. So there's significant scale advantages that we have. Of course, we had to adapt our network, just the e-commerce growth is what we are doing right now and which we have done. We are actually very -- we have done a pretty good job of adapting to the changes, but I think with more to come, and the technology also plays a significantly critical role as we move forward. So for e-commerce is ultimately a good thing for FedEx.

But do you think it's fair to say that the growth of e-commerce has brought margin pressure for the industry?

Well, [indiscernible] go, yes, but if you now look at what we have done with FedEx Ground and even in the literally in the last 3, 4 years, you can see the margins continue to expand. So it's even with this significant e-commerce, it's just that our network now adapted just to environment. And we are -- people talk about the last mile, but forget about the first few thousand miles. And there is -- there are only very, very few people, very few companies who can deliver.

But if we just kind of think about the diagnosis of some of the problems before, obviously, we're coping and we adopting, but there was some margin pressure there from e-commerce. I mean it looks like in the data.

If you look at -- that's what I said, there was a period of adapting to this. But I think now we have moved on -- so these things have changed, and we had to put some specific infrastructure to support...

So what about price and the challenges you have around the residential delivery part of the business just in general, less productive than...

No, I think I'm really proud of the way that we have managed our revenue management function. And this is something that's differentiated in the market for us. We look at this very, very carefully. And if you look, close your eyes, pick up any quarter that -- in the last 20 years, pick one, open and compare our yield versus our competition, we'll be better. And it's just we've done a much, much better job of managing because the value that we provide for our customers is significant. And we'll provide -- because of that, we can -- we need to balance out the needs of our customers and the shareholders and our employees, and we do that very carefully. And again, we have done a really remarkable job on the revenue management side.

Before we kind of dig deeper into the pricing question, I wanted to follow up on one of the things you mentioned before. Some of the investments that you needed to do. What did you need to do to adapt that?

Yes, it's a great question. Yes. So when we had to put in what we call regional sort facilities, for example, in FedEx Ground and so then we're able to post in and out of that facility to some of the local market because the demand for e-commerce...

The regional sort meaning like the Autosat facility.

Well beyond Autosat into what we call RSFs and we set them up during the pandemic. And they serve very well in terms of moving piece, especially the e-commerce business [indiscernible] to RSFs and into the customers ends.

So basically routing some of the higher-volume residential stuff around the commercial...

Yes.

Okay. Interesting. So if you think about again, back to a comment on whether the moat has been reached, right? Obviously, it does feel like it was Amazon controlling its own supply chain just to deliver component [indiscernible]. How do you think about the rest of that market growth opportunity?

Yes, I think a very good question. So the point here is that the e-commerce market, I think, I suspect Amazon is about 40% to 50% of the market. Now we are partnered with all the retailers and every one of them, we have a partnership with them. And we are their transportation logistics arm and their growth of e-commerce. If you look at the growth of e-commerce or some of these big retailers, they're also growing very fast. And we are now linked in some of the best relationships we have is we are linked at the data level at the technological level right behind the point of order at the end customer. And we are able to get that information into FedEx' hands, 2 hours before [indiscernible]. But most importantly, we're able to let our customers know how best to optimize their supply chains, given the latest in weather traffic conditions and so on. And we are also able to get the end consumer significantly more visibility. So we are now really strategically the hookup with many of the retailers who enable their e-commerce, which is 60% of the market, and that's also a -- so that there's a significant balancing act that's happening.

Okay. So when you think about the -- going back to the revenue management side of the equation, you mentioned you're really proud of the way the team has sort of helped to adapt and respond, how has the growth of e-commerce created challenges for you on that pricing front? Because it does seem like there's some perception out there that delivery is free and it's harder to do great in that market. And maybe having an impact as they're offering some excess capacity in some markets.

No, I think you're talking about 15 million packages per that goes through the system. And I think we have -- the value that we provide our retailers is very, very clear. And so we have very productive conversations. I mean for example, [indiscernible] store charges and that's basically changed the industry, how we deal with peak for example. So I think we have -- overall, the idea -- there's a significant piece of the market that we play in e-commerce, it is growing. And we have now have a very efficient system to deliver it. We have a good revenue management philosophy, good pricing mechanisms, deliver value for all our stakeholders. I think we're in a good place here. And especially as the industrial market comes back to some kind of quiet, I think we'll be [indiscernible].

Let's kind of dig into that for a second, the industrial part of the economy because a lot of times investors focuses purely on e-commerce and the potential disruptive effects and all the queries you can read about. The B2B part of the business, it does feel like that growth has been a little bit more subdued in a market for the last couple of years. What do you think is driving that? I mean, what do you think about the outlook maybe looking out for 5 years in the B2B side?

Yes. So first of all, that's why -- when we -- the goods that we move through our system are the high-value goods to the economy. That's why we estimate about -- we move about $2 trillion worth of goods to be actually -- value the goods that we move through the system. So these are the things that go through FedEx, whether it is medical equipment, whether it's high fashion, whether it is electronics and so on and so forth. So what we are now seeing is the tail end of the pandemic repercussion. And that's where the industrial goods caught up in this bigger supply chain pool, the fact that I talked about. But again, like I said, if you actually close your eyes and look 4 years, we're still doing 6% CAGR. It's just that the recent 2 years I've been on the downdraft. And the great news for FedEx is that we have now uniquely growing operating profit even in a declining demand environment. And so there's -- when this bottoms out and comes back, and I'm not going to sit here with timing right now, that's not good as the same quite period, is that there's significant leverage in our business, especially as we have shown our ability uniquely in our industry to generate operating profit growth despite the revenue decline.

Okay. So as you think about the network integration, you mentioned you're starting to take the time definite error and the [indiscernible] putting together into a new solution, right? The driver of this is efficiency gain capabilities...

I think it's very simply when we have -- as I said in my opening remarks, we have 2 trucks coming to a business delivering multiple packages and significant density in [indiscernible]. But when you're delivering to your house, and you ordered 2 packages and 1 is coming from 1 truck and the another one in the other truck, that's where we have to do the restructuring. So the Network 2.0 ultimately delivers one package, one truck, one neighborhood, and that's where the efficiency comes from. And it requires a lot of work, and we have prepared for it. We have -- technology had to work, facilities have to work. And so that's -- we're excited about the progress we're making so far.

So it takes a lot of prework but we've announced this a while back. We're now getting to the point where the rubber is going to start meeting.

It already is. Already is.

The express and the ground overhead structures are going to be collapsed.

Well, the -- so I'm going to distinguish between the network that is coming together and the organization. So as of June 1, we're going to an organization construct [indiscernible] and so that work has already been done. And we're going to a new structure starting in from Saturday. Then over the next 2 or 3 years, FY '27 is when we get through the network integration. So it's just -- but the work is well underway. I mean, and we are making progress. We've been making very steady progress, keeping in mind that the customer experience should get better. That's our mantra here, making sure our customer experience gets better.

So as we're thinking about putting these networks together, is the idea, take all the volumes, stick it in one network, shut out a bunch of buildings, keep the existing assets? Like how should we be thinking about the capacity implications?

Well, the -- if you think about it, I think we will be able to bring down the total footprint of our facilities and to be able to serve the same market. Now we, of course, when it does go, we can go into it as well. So we'll get more efficient in the number of facilities we have, we get more efficient in the utilization of our routes and all the way around and of course...