FYI | Jun 17 2010
By BTIG market strategist Mike O'Rourke
Today FedEx reported Q4 and FY 2010 earnings. It is well known that from a macro perspective, FedEx provides important insight into the state of the global economy.
The top headline from the release was that FedEx was providing 2011 guidance in the US$4.40-US$5.00 range. The midpoint of that guidance is US$0.42 below the street consensus estimate of US$5.12.
For the past few months, we have been noting that we do not have confidence in the current 2011 estimate of US$95 for the S&P 500. Today, FedEx provided an example of the convergence necessary for 2011 earnings estimates to move lower and reasonably align with 2010 estimates which still have potential to move higher.
FedEx's new guidance of US$4.70 still indicates 25% year over year EPS growth. A lack of confidence in that US$95 estimate for next year is likely one of the many reasons the markets multiple is compressed.
Investors should be on the lookout for additional convergence between 2010 and 2011 earnings estimates. FedEx traded down on the news, but that should not be surprising considering the stock trades at a 50% premium to the market's multiple.
In reference to the broad economy, the FedEx news was a sheep in wolf's clothing. For a year, we have talked about companies being lean and mean. As revenues have begun to return in the first half of 2010, the lean cost structure has helped margins and boosted profits.
As the recovery progresses, companies will need to begin hiring again, increase capital expenditures and reinvest in their respective businesses. In short, they cannot plan for future growth using an organization that has been cut to the bone. FedEx management used the term “strong” 15 times during the call.
The reduced guidance was not the result of a poor business outlook. Instead it was the process of returning the business from that lean crisis mode. Factors lowering the guidance costs related to the maintenance to bring mothballed planes back online, increases in variable compensation for employees, restoring half of the 401K match, and higher pension obligations due to the current low historic return rate of markets.
During the conference call, FedEx management was asked about the status of the US$3 Billion in costs they have eliminated during the recession. Half of the reductions were expected to be permanent. The FedEx management response sums up the dynamic we are talking about:
"You know, the $3 billion and 1.5 (Billion) was obviously a non GAAP analytic snapshot at the time. And then after that we go on and manage our business so obviously, a lot of those cost saves fell to the bottom line.
“We absolutely crushed our business plan last year, and funded a significant amount of annual incentive compensation that we didn't think we were going to fund we're also being very aggressive in international now so we're spending some of that permanent savings in a different bucket. So the savings is still there. We're just reinvesting it very heavily.
“Obviously the earnings are better than they otherwise would have been. I am very comfortable that we have significantly reduced our cost structure by the amount that we said, that we're adding in other areas as we grow and become more aggressive. I think the rate we've given you is pretty thrilling from an EPS growth rate.”
If a company that serves as a barometer of the global economy is going to reduce its earnings guidance, this is the healthiest manner in which one could see them to do it. Any investors sharing the belief that 2011 estimates are too high, should not be surprised when we see them cut.
The views expressed are O'Rourke's, not FNArena's (see our disclaimer).
Disclaimer: https://btig.com/disclaimer.php
