FDX: Substantial Acceleration



FedEx announced the accelerated retirement of its old, high cost aircraft.  Our thesis on FDX focuses on the FedEx Express restructuring opportunity. A key component of that restructuring is the need to eliminate high cost old aircraft.  Broadly, we believe the Express restructuring is a meaningful inflection point in FDX’s operating history, as the company refocuses substantial attention and capital spending on improving Express margins.  Today’s announcement appears to be a meaningful acceleration of that restructuring.


From our standpoint, the accelerated retirements are an extremely positive development.  As long as the company is able to maintain adequate capacity and manage the accelerated schedule, the elimination of high cost aircraft should bring forward the margin improvement that is the core of our thesis.  We have no doubt that the street will focus on what the retirements imply for the demand environment.  That said, looking at the scale of the acceleration in retirements, it seems possible that there will be a subsequent announcement related to accelerated deliveries/contracted capacity/network restructurings that facilitated todays announced actions (i.e. it may not be all because of weaker demand.)


For what seems to be a very meaningful announcement, we would have preferred more specifics.  However, anything that attacks FedEx Express’s cost disadvantage relative to competitors while rationalizing excess capacity should be a welcome development.



Positive:  Should Have Been Done Years Ago, So Faster Is Better


Accelerating the retirement of 86 aircraft out of a fleet of a few hundred commercial jets is a very meaningful move.  It also highlights the scale of FedEx’s high cost aircraft problem/opportunity.  Further, by our count, FedEx still has over 20 727s, which are now scheduled for retirement by July 1, 2013.  This move should pull forward substantial restructuring benefits.


While it is difficult to pin a number on exactly what the benefit of the accelerated retirements will mean for FY2014 without more specifics, we believe the improvement will be substantial relative to our former expectations.  If we assume 30-35 incremental aircraft or so are retired before the end of FY2014, our first cut estimate is $300-$600 million in FY2014 savings relative to our previous expectations (we still had them with some 727s).  That estimate could be low because of increased density in certain routes from capacity reductions.  It is difficult to estimate the timing of the additional retirements from the information provided and we have not assumed a revenue impact from the retirements or any impact on pricing.  As we get additional information, we will revise the estimated savings, but that is our best guess tonight.


Estimation error aside, our first cut estimate should emphasize the substantial scale of the renewal programs and the impact of the announced accelerated retirements. It will be interesting to see if FY 2014 estimates move higher as the street incorporates today’s announcement.



Negative:  Suggests Demand Outlook Has Eroded


“We can accelerate retirements of the MD-10, the 727 or the A310 fleets, if demand erodes. If demand were to rebound significantly, we have the ability to operate these assets until incremental lift can be acquired.” David J. Bronczek 10/10/2012


This accelerated retirement schedule certainly may suggest that FedEx Express projects “slower economic growth than previously forecast.” While that may be seen as a negative, the operating environment for FedEx Express will be what it will be.  At the margin levels achieved last quarter, there was so little profitability that Express really did not matter.  Margin expansion is critical for FedEx Express and accelerated aircraft retirements should expand margins.  Capacity reductions in the face of weak demand also tend to be rational.


However, it may not all be demand related.  As indicated on the FYQ3 earnings call, network restructuring may have allowed for capacity reductions targeted at older aircraft.


“While FedEx Ground and FedEx Freight posted solid financial results, the third quarter was very challenging for FedEx Express due to continued weakness in international air freight markets, pressure on yields due to industry overcapacity, and customers selecting less expensive and slower-transit international services. In response, as Dave Bronczek will tell you after Alan Graf's remarks, beginning April the 1, FedEx Express will decrease capacity to and from Asia and will aggressively manage traffic flows to place lower-yielding traffic in lower-cost networks. We are assessing how these actions may allow FedEx Express to accelerate the retirement of more of its older, less-efficient aircraft as part of our fleet modernization program begun several years ago. We remain focused on our strategic cost reduction programs, which are ramping up and on target.” - Frederick W. Smith 3/20/2013



No Need for Ground/Express Integration


While some have called for the integration of the Express and Ground networks, we do not see a need for that.  FedEx Express has plenty of scale in the Americas to compete.  FedEx Express should attack its own costs structure, as it is doing, before risking the substantial labor cost advantages that FedEx Ground enjoys.



For Perspective… 


The table below shows an expected aircraft schedule as of November 2012.  The changes announced today are likely to alter the schedule substantially.


FDX: Substantial Acceleration - rrr1





You can see here some of the reasons we do not like a simplistic sum of the parts valuation approach, but we find the estimates in the table below useful for understanding the opportunity inherent in the FedEx Express restructuring.  The table suggests nearly 70% upside in FDX shares if the restructuring is successful and little downside if it is not (assuming FedEx Express does not start to lose meaningful amounts, which seems unlikely to us).


FDX: Substantial Acceleration - rrr2


Keith's Top-5 Tweets Today

Takeaway: A quick snapshot of Keith's top Twitter observations today.

I get the worry - we are all human; my process said dont worry about the 50-day moving monkey line, not in play @KeithMcCullough 3:52 PM


What we wanted to see this morning was the emotional tweeting of frustrated bears, on the lows of the day

@KeithMcCullough 3:13 PM


Consensus is freaking out again - that is a very good thing for the bull case $SPY

@KeithMcCullough 10:38 AM


Interesting to see bears cling to the very few data pts left that aren't accelerating

@KeithMcCullough 10:03 AM


2 hr selloff on a summer friday, after excellent US #GrowthAccelerating data (PMI 58.7) doesn't a bear mkt make

@KeithMcCullough 5:38 AM


Keith's Top-5 Tweets Today - tweet

Trade of the Day: CCL

Takeaway: We covered our short on Carnival Cruise (CCL) at 10:07am this morning at $32.67.

Earlier this morning we booked our 5th consecutive gain on the short side of Carnival Cruise (CCL). In case you hadn’t already noticed, we enjoy winning here at Hedgeye. CCL is immediate-term TRADE oversold, within a bearish TREND. Winning … it’s a good thing.


Trade of the Day: CCL - CCL


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An End to “Pump and Dump”?

Takeaway: The SEC steps up to prevent pump-and-dump scams – and Tweets it to make sure you know!

This note was originally published June 03, 2013 at 14:38 in Compliance

Like the US economy, the SEC appears to be recovering from the depths to which it had sunk.  While it is premature to determine the scope of the “new” Commission under Mary Jo White, a number of recent actions show increased diligence in certain key areas.


This morning the SEC Tweeted piece news on a corner of the business which has seen more than its share of financial hanky-panky.


First, though, you may be amused to learn that the SEC tweets.  In fact, the SEC has three separate Twitter offerings: SEC News, SEC Investor Ed, and SEC Careers.  SEC News has over 192,000 followers, while the investor education stream has only some 35,000, and Careers around half that – about 18,000.


We think it’s important to follow the Commission’s work – and “following” the SEC gives you up to date information on what the SEC is up to.  It also tells you what the SEC itself believes is important to burnishing its public image – a task that still has a way to go.


Today’s tweet reads: “SEC Suspends Trading of 61 Companies Ripe for Fraud in Over-The-Counter Market,” a follow-up on a major action last May when the Commission’s Microcap Fraud-Fighting Initiative suspended trading in 379 dormant “shell” companies (SEC Release 2012-91, May 14, 2012). 


Shell Companies – In a typical organization, John Smith starts work at Your Company, Inc, and is assigned  Using this email address, he proceeds to do business on your behalf.  Since you want John to start doing business right away, it’s a priority for your tech team to set up his email, phone extension and voice mail-box.  But when John leaves your employ, are you equally diligent in disabling his communication abilities?  John may move on to his new endeavor with nary a backward look.  But just imagine how much trouble might be created by someone surreptitiously using John’s email to create a false set of business transactions.  Managers think that “discontinued” means “gone” – but not in the world of communication technology.


This internal miscreant could attempt to place buy and sell orders on behalf of Your Company, to move money out of bank accounts, to shift assets around – in short, they could do a whole lot of damage.  Since John is no longer with you, you wouldn’t ever think of monitoring communication over his email address.  By the time you figured out where the problem was coming from, it could be too late. 


So the first lesson is: make sure your IT department disables those unused email accounts.  Just because there’s no one there to use them officially, doesn’t mean there’s no one using them at all.


How does this relate to stock trading?


Announcing the result of last year’s “Operation Shell-Expel,” then-director of Enforcement Robert Khuzami said “Empty shell companies are to stock manipulators and pump-and-dump schemers what guns are to bank robbers.”  In a Pump-N-Dump scam, fraudsters acquire the stock of a dormant microcap company.  Stock of companies that have ceased doing business can reside in any of a variety of “inactive securities” accounts at a brokerage firm – which would be only too happy to clear it off their books for a nominal fee.  Scammers can often acquire over 90% of the stock for a couple of hundred thousand dollars.  They then launch a promotional blitz to get people like you to buy as much stock as possible, as quickly as possible.


If you receive an email promising you the equivalent of “major new find to cure cancer, incredible opportunity in low-priced stock!!!” you are probably on the receiving end of a shell-company scam.


What’s Different Today? – The SEC’s mandate is based on a “disclosure regime,” requiring companies that want access to the public marketplace to fully disclose all material information about their business.  As with the prospectus for a new securities offering – the Disclosure Document extraordinare – the SEC passes on the Completeness of the information, but not on its Accuracy.  There lies the rub.


For years, when dormant “shell” companies started trading again, SEC disclosure rules required them to bring their filing information up to date – but not to verify whether it was true.  In fairness, the SEC are not detectives – nor do they have the staff to send inspectors to interview the executives of every fly-by-night operation that tries to sell you stock.


It’s very much like having a membership in an exclusive club.  John Smith, member of the Club of One Hundred (so called because it is limited to one hundred members, each one of which is pledged to give full financial support to any other) dies.  His death is not reported to the Club.  Three years go by, and someone else finds John’s membership card among his cast-off effects.  The impostor shows up at the Club and produces the card.  “Ah, Mr. Smith!” he is told.  “We would love to welcome you back.  But you see, your membership has lapsed because your dues have not been paid for three years.”  At $100 a year, it will cost $300 to re-activate the membership – which sum the impostor gladly hands over.  The Club does not ask for any verification of his identity, and by the time the members learn of the previously unreported demise of their lamented former member, the false “John Smith” is on a tropical island spending his ill-gotten millions.


For years, all the SEC required was that the public reporting documentation be filled out in full.  To facilitate capital formation, smaller companies were permitted to register and report directly on EDGAR, the Electronic Data Gathering, Analysis and Retrieval system set up by the SEC in the mid-1990s, bypassing the manual review process.


Pump-N-Dump schemes tend to run very quickly, which means that by the time you realize what’s going on, you’ve already been scammed.  Stock is handed out liberally to small shady operators, who mix it in with the stock they sell for the promoters, as those at the head of the Pump-N-Dum pyramid are known.  This way everyone gets paid.  Except you.  For more about the world of stock scammers, and other depressing insights, read our Hedge e-book Fixing A Broken Wall Street, available at


The SEC suspends trading in a stock when there is a lack of adequate up to date information, when the Commission has serious doubts about the accuracy or truthfulness of the company’s public information, or when there are concerns that the stock is being manipulated.  This initiative to track down and prevent trading in ripe-for-fraud shell companies is an important step.  Under the Commission’s own rules, they can’t just pull these stocks from circulation.  The suspensions are set to run for ten days and should be a first step towards de-listing these issues before they rise, zombie-like, to eat the living flesh of your portfolio.


Protect Us From Ourselves? – Investor Protection is not adequately served by mere warnings about risks.  See, for example, the NY Times, 24 May, “Growth in Options Helps Brokers But Not Small Investors.”  Brokers are required by law to warn investors about the risks of options trading.  But the warnings only seem to make investors more keen to trade exotic instruments.  According to the Times, options trading has risen to nearly a quarter of customer business in some areas – but options investors’ returns are only about 20% of the global returns for stock and bond investors.  “Buyer Beware” is a joke.  In the financial markets, people believe that they are told not to do something because some Really Smart Guys want all the profits for themselves.


The SEC, by taking the extra step of actually digging into the information, and putting the regulatory kibosh on trading, is doing something they haven’t been known for of late: making the markets safe for investors.


Go figure.


Moshe Silver

Managing Director / Chief Compliance Officer


Stories Bears Tell Themselves

Takeaway: These are interesting times for bearish market story tellers.

(Excerpted from this morning's Hedgeye conference call)


These are interesting times for bearish market story tellers. They get one late Friday afternoon, light volume sell-off and now all of a sudden they’re asserting how they’ve been right all along. The reality is that what they have wrong, we have right, namely the emergence of #Growth Accelerating.


It would be disingenuous at best to suggest that bond yields aren’t ripping higher because growth is accelerating and that the Fed is going to likely begin to get out of the way for precisely that reason. 


Don’t forget that back in March, and early April, people were poo-pooing the market rally saying, “I don’t like that the defensives—consumer staples and utilities—are leading." Well, now they’re lagging. 


Only two of the nine S&P sectors in our model are broken from an immediate term trade perspective. You guessed it—Utilities (XLU) and Consumer Staples (XLP). What is leading now are pro-growth sectors like Financials (XLF). Utilities (which were down 9% in May) are bearish trade and trend. We would short them on a bounce.


The opportunity right now lies in taking advantage of the fear. Taking advantage of the fear that growth is going to surprise on the downside which it obviously has not.


Stories Bears Tell Themselves - bear

Mortgage Rates Go Vertical

Takeaway: 30Y Mortgage rates backed up 35 bps in the last week and 70bps in the last month. Refi activity and affordability have taken a hit.

Last week saw a significant back up in 30Y Residential Mortgage Rates as the national average rose 35 basis points W/W to 4.10% from 3.75% the week prior.  From the near historical low of 3.40% reached back on May 1st, we’ve seen an expedited 70 bps backup in rates over the last month. 


The move in rates holds a few notable impacts for housing.  First, the increase in mortgage rates should have a (unsurprisingly) significant, negative impact on refinancing activity – something that has already manifest in the MBA mortgage application data with refi activity down 12.3% in the last week and 23% over the last month.  This contrasts with Purchase Activity, which was actually up 2.6% in the latest week and down just 2.3% over the last month.   


While we believe the positive Giffen cycle in housing (see Here for fuller discussion) should continue to predominate with demand chasing higher prices in a reflexive fashion, higher interest rates have a direct, negative impact on housing affordability. 


Previously, we have shown (Here, slide 49) that under standard median income and DTI assumptions for a 30Y Freddie Mac Mortgage loan, a 10bps change in rates equates to an approximate 1.0% change in affordability.  A continued rise in interest rates would serve as a headwind to a further acceleration in home values, particularly as HPI growth comparison’s get steeper. 


While we would view the breakout in treasury yields alongside the material sector level performance divergences (XLF  +6.1%, XLU -9.0% in May) as pro-growth signals, with the housing recovery a key tenet underpinning our domestic growth outlook, we’ll certainly be monitoring rate impacts on affordability closely here.  


Mortgage Rates Go Vertical - 30Y Mortgage Rate 060313


Christian B. Drake

Senior Analyst 


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