FedEx – Incorrectly Packaged
Having now spent 26 years in the research business, equity and corporate, I know from bitter experience how unusual it is to get any form of immediate confirmation of a thesis (or a recommendation). Consequently, I am incredibly grateful to FedEx this morning for an earnings report that helps to confirm the very interesting and differentiated work we published last week on optimism and its pitfalls.
Optimism is a real problem in the Industrials and Basic Materials space as companies that over-estimate the earnings capacity of their business tend to make a number of strategic errors that lead to underperformance and much lower shareholder returns than their more conservative peers. FDX was one of the 20 companies we identified last week that over time has a too bullish view of its own future. This is not an industry or even sub-industry issue as there are plenty of transport companies that are more conservative and more successful as a consequence and UPS, which is essentially in the same business as FDX, while still too optimistic, does not have the same degree of optimism. This year FDX has seen close to 15% negative revisions while UPS has seen less than 5% (granted these are not the sane fiscal years, but that does not explain the difference).
FDX has seen an average of around 10% negative revisions from January 1st through year end over the last 11 years, while UPS has an average negative revision of 2%. At the other end of the scale, JB Hunt has underestimated EPS growth by an average of close to 10% each year. In the charts below we compare return on capital for FDX and UPS, and FDX and JBHT. The divergence suggests that the optimism at FDX relative to UPS of JBHT is resulting in overspending on projects/ideas that have a lower return that originally expected. We have proved the same pattern for the Industrials and Basic materials group as a whole and for individual sectors within the group – the results are compelling and raise all sorts of question for the corporate managements that over-estimate, most obviously – why?
Interestingly, despite the weaker return on capital trend, FDX has not generated lower shareholder returns than UPS over the last 11 years on average, but it has significantly underperformed both JBHT and CHRW, which also has a history of conservative projections – see chart.
Note that central to our thesis is the assertion that consensus estimates at the beginning of any year are a function of company guidance. We base this assertion on an increasing level of risk aversion on the part of the analyst community and the averaging effect, which minimizes the impact of any outliers.
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