Warning shot from FedEx as margin pressure intensifies

Warning shot from FedEx as margin pressure intensifies by Saxo Group
FedEx’s earnings show increased margin pressure which become a hot topic in the upcoming Q3 earnings season.

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.

Topics: Equities S P 500 index Nasdaq Corporate Earnings Earnings Releases Fedex