FedEx: Still Waiting for an Economic Recovery

Many investors and economists are betting that an end to the recession is on its way. But the latest results from FedEx (FDX) pose a grim question: What if economic recovery gets lost in transit?

Shipping firms—especially giants such as FedEx and archrival United Parcel Service (UPS)—are closely watched because the strength of their businesses serves as a useful gauge of activity in the broader economy.

In its fourth quarter ending May 31, FedEx's revenues fell 20%. The shipping giant posted a loss of $876 million, or $2.82 per share. Without one-time accounting adjustments, the company posted earnings of 64¢ per share, down from $1.45 a year ago.

FedEx chairman and Chief Executive Fred Smith said the company he founded has faced "the most difficult conditions in our company's history and in fact the most difficult economic conditions that the modern world has seen since the end of World War II."

That much is clear, but what about hopes that the economy can recover later this year and into 2010?

Positives? Smith cites the S&P 500

Speaking to analysts on June 17, Smith was less than enthusiastic. "We do see signs of stability as the rate of decline appears to have leveled off," he said, adding: "How long this bottoming out process will take and how strong the recovery will be remains of course uncertain. We believe, however, the worst of the recession is likely behind us."

Among the positive trends for the shipping industry, Smith said: Conditions in financial markets have improved significantly, with the broad Standard & Poor's 500-stock index up 35% since March 9.

Even if the economy remains in a funk, businesses might still need to restock inventory later this year, he added. Improvements have shown up in economic data, including measures of the confidence of consumers and global trade activity.

However, FedEx executives' optimism was muted by the fact that few of these trends have translated into results. Indeed, the company warned of more pain to come in the current quarter as rising fuel costs take a toll on the bottom line.

A recent survey of trucking companies conducted by Longbow Research showed similar pessimism. In an April survey, 61% of respondents had a negative outlook for trucking demand in the next three to six months. In the May survey, released June 17, that rose to 68%.

Diesel fuel up 28% since March

As one anonymous respondent at a trucking company based on the east coast put it: "We keep hoping to see a rebound in freight volumes, but we're just not seeing it, whatsoever. We are not even experiencing any seasonal uptick. The market is very difficult and it doesn't appear to be meaningfully improving at all."

Longbow analyst Lee A. Klaskow listed the industry's problems: "Weak demand, irrational pricing, and excess capacity are being exacerbated by higher fuel costs," he wrote, noting that diesel fuel is up 28% since its recent low in mid-March.

Speaking June 17, the head of FedEx's freight division, Doug Duncan, noted that the trucking industry's decline actually began in 2006, before the overall economy slipped. The catalyst was the "housing crunch," he said. "The whole industry is down a little better than 20% since its peak of 2006 and I don't think we're going to have the kind of [gross domestic product] growth that's going to get us back to that capacity quickly."

Key parts of the economy have contracted so severely that many believe the transportation industry must also shrink indefinitely—particularly if the recovery is slow.

FedEx cut back on costs in the last year, grounding aircraft and laying off employees. Executives said the firm might make more cuts if the economy is slow to rebound.

FedEx: "a macro bet" on the economy

One "silver lining" of high fuel prices is that they could cause some weaker trucking firms to leave the business, reducing competition and "irrational pricing," Klaskow wrote.

No one is doubting that a company such as FedEx, with its strong balance sheet, will survive. But, as UBS (UBS) analyst Rick Paterson notes, "cost control will only take FedEx so far." Most of investors' hopes for the stock, then, rely on a revival in the economy. "FDX stock is essentially a macro bet," Paterson wrote June 17.

"If the economy does well, FedEx will do well," says Bernie McGinn, president of investment manager McGinn, McKean & O'Neill, which owns FedEx shares.

While McGinn sees signs of hope for the economy, he believes a recovery will be uneven. "Half of people think we're improving," he says. "Half of people think it's getting worse. And nobody really knows."

FedEx's results are the latest evidence that while economists and investors hope for the best, the economy remains on a rough and rocky road.

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