background image

Warning shot from FedEx as margin pressure intensifies

Equities 8 minutes to read
PG
Peter Garnry

Head of Equity Strategy

Summary:  Last night FedEx surprised the market with cut to its fiscal outlook due to labour shortage and wage pressures with some hubs showing a 25% increase in wages. We discuss in today's equity update whether FedEx's earnings are a warning shot for investors of what to expect in the upcoming Q3 earnings season. Rising input costs could become a bigger issue for companies in the coming quarters and how they choose to respond to rising prices will determine the level of inflation in 2022.


As we describe in our Market Quick Take this morning, equities are rebounding on good news from PBOC and Evergrande which for now are stabilizing the situation around the Chinese housing market. But today’s equity update is not going to focus on China, but instead on earnings from Lennar on Monday and FedEx last night. Both earnings releases are potentially warning shots of what to expect in the upcoming Q3 earnings season.

FedEx margins are under pressure due to wage pressure

FedEx reported earnings last night and surprised investors negatively by cutting its fiscal outlook only one quarter into the new fiscal year. How could the company be so wrong in its prediction? It is a good question but it seems that the low wage worker shortage is getting increasingly worse in the US and FedEx is reporting that in some hubs wages are up 25%. This is putting pressure on operating margin which landed at 6.8% vs est. 8.5% expected for the quarter causing EPS to only show $4.37 vs est. $4.92. The worker shortage is impacting network efficiency so FedEx is using weekend premiums to mitigate the negative effects.

On the positive side, FedEx sees strong volume growth and e-commerce segment is expected to grow 10% p.a. until 2026 which will require many more truck drivers and investments in infrastructure. It is clear that FedEx has held back on raising shipping rates too much which has negatively impacted profits. The company is announcing that effective 3 January 2022 that freight rates will increase 5.9% to 7.9%. Unless e-commerce businesses take that out of their profits this will lead to higher prices on consumer goods in 2022.

Later today we will get earnings from the US consumer food company General Mills, and the expectation is that the business could experience some margin pressure from rising input costs from commodities, wage pressure, and rising supply chain expenses.

Lennar sees dark cloud around supply issue into 2022

The US homebuilder Lennar reported good Q3 earnings (ended 31 August) on Monday but guided lower deliveries and orders in Q4 due demand coming a bit off because of higher prices for new home construction. Lennar delivered its highest ever gross margin in a quarter at 27.4% on 18% revenue growth showing that US homebuilders are able to pass on higher input costs from commodities without hampering growth too much. The homebuilder says demand remains strong but supply issues are constraining deliveries for now and situation is likely to extend well into Q2 2022.

The take-away from Lennar is that the US consumer and housing market remain strong and the low interest rates are offsetting higher building prices for now. This part of the economy companies are able to pass on higher price, and supply issues will continue to hold back growth into 2022.

Online vs offline companies

Last night we also got earnings from Adobe, the wunderkind of the software industry, that were strong and despite a better than expected guidance investors were not satisfied. Unlike the margin pressure and supply constraints of Lennar and FedEx, Adobe expanded its EBITDA margin to 41.8% for the past 12 months and revenue growth remained strong above 20%.

Adobe’s results are in stark contrast to Lennar and FedEx and the other companies operating in the physical world. Digital companies do not have the same constraints on expanding supply of their services and their delivery does not require costly shipping transportation. This different operating environment is clearly seen in the profit margin between the S&P 500 and Nasdaq 100. Digital companies have higher margins and higher return on capital and hence grow capital faster. This has driven equity valuations on technology stocks higher and it seems recently that we have reached a pressure point in the physical world where it is not big enough to support politicians ambitions on the green transformation and the demand for EVs and electronic devices. The online vs offline world is something we will touch more on in future updates.

22_PG_1

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
Full disclaimer (https://www.home.saxo/legal/disclaimer/saxo-disclaimer)
Full disclaimer (https://www.home.saxo/legal/saxoselect-disclaimer/disclaimer)

Saxo Bank A/S (Headquarters)
Philip Heymans Alle 15
2900
Hellerup
Denmark

Contact Saxo

Select region

International
International

Trade responsibly
All trading carries risk. Read more. To help you understand the risks involved we have put together a series of Key Information Documents (KIDs) highlighting the risks and rewards related to each product. Read more

This website can be accessed worldwide however the information on the website is related to Saxo Bank A/S and is not specific to any entity of Saxo Bank Group. All clients will directly engage with Saxo Bank A/S and all client agreements will be entered into with Saxo Bank A/S and thus governed by Danish Law.

Apple and the Apple logo are trademarks of Apple Inc, registered in the US and other countries and regions. App Store is a service mark of Apple Inc. Google Play and the Google Play logo are trademarks of Google LLC.