Results from FEDEX

Federal Express reported results yesterday and I wanted to highlight their numbers here on the blog to demonstrate why it is important to parse a business’s results. This is especially true because the tendency of media outlets is to emphasize the status quo. And the current economic status quo is that things are garish, ugly and scary. So of course that is what is reported.

First of all the raw, un-analyzed numbers are as follows:

• For their fiscal fourth quarter, revenues declined 20% (!).
• The net loss for the fiscal fourth quarter was $876 million or a loss of $2.82 per common share of stock. This compares to a loss a year ago in the same quarter of $241 million or $0.78 per common share of stock.
• The results included a $1.2 billion writedown of the worth of the assets of Kinko’s which FEDEX acquired in 2004 for $2.4 billion.

The headlines yesterday generally emphasized that FEDEX had lost $876 million. However, what did Fred Smith, the company’s very famous CEO have to say about the results:

“…the worst of the recession is behind us…” and also, “…the rate of decline appears to have leveled off…”

Interesting. Why the stark contrast? First of all, let’s look at that $1.2 billion writedown in the value of Kinko’s. How does that number compare to the total loss for the fiscal fourth quarter of $876 million? Clearly it is a much larger number and is the sole reason that FEDEX reported a loss in the quarter.

So what exactly does a writedown in the value of Kinko’s mean? When a business purchases another business, the price paid for that business is added to the assets of the acquiring corporation. In this case, FEDEX paid $2.4 billion back in 2004. However, accounting rules require that if you pay more for a business than the market value of all of the stock of a business, and all of the debt of the business, that you apply continual stress tests to the purchase price of that business to ensure that the earnings from that purchased business are meeting your expectations. In other words, accounting rules say: “If you are going to pay more than fair market value then you have to justify the price. Ultimately, if the premium paid is not justifiable then you have to write down the value of the price paid.” Does this make sense?

Thus, in the fiscal fourth quarter, FEDEX failed a stress test with regard to Kinko’s and so it had to write down the worth of its 2004 purchase. In other words, FEDEX overpaid by almost 100%! But this is not the interesting factoid in our current context. Nope. What is interesting is that the value of Kinko’s has likely been suspect over the entire 5 years since it was purchased, yet the entire writedown in the value of Kinko’s takes place in one single quarter! That doesn’t make any sense, does it? But that’s the way the accounting rules are written. So would a financial analyst be justified in excluding the writedown of Kinko’s to analyze this quarter’s results? Most likely. So let’s do just that.

Sans the Kinko’s writedown, Fedex earned $0.64 per share – that’s actual profit folks – which compared to analyst expectations of $0.52 per share. The company did lower expectations for the upcoming fiscal first quarter, however, they are still predicting making a profit.

But let’s return to the above “exclude the writedown” discussion so that those of you interested in empowering your investor selves can do just that. Why did I say that an analyst was “most likely” justified in excluding the writedown? It all has to do with timing. Ideally when you are adjusting a company’s financial results you would ideally like to know the trajectory and timing of the decline of the worth of Kinko’s. If you had that knowledge then you would go back five years in history and adjust the results each year to reflect more accurately the decline in the value of Kinko’s. Because the amount of the decline in the worth of Kinko’s was entirely taken in one quarter, yet the actual timing of the decline in the value was over five years, it means that FEDEX’s results were over reported for almost 5 years. This is because FEDEX was not getting docked for the Kinko’s decline until just this moment.

So how would you estimate the trajectory? This is where you switch from anal-yst to art-ist. One technique is to look at a competitor to Kinko’s – say another packaging/shipping/copy store and see what their results have been over the last five years. Ideally you would want to look at a business that does exclusively that. Unfortunately, Mail Boxes Etc. was acquired by UPS and the results of MBE are no longer easy to breakout from the conglomerate results of UPS. So you could look at a smaller player to see earnings trajectories. You could also ask the investor relations people at FEDEX. However, I doubt they would be entirely forthcoming with those numbers. The reason is that the specificity of those numbers would be considered information likely to hurt competition if they were disclosed. However, they might say something like: “half of the decline has been in the last 18 months.” That is useful information.

In conclusion, FEDEX’s numbers were not so bad, in fact they were kinda “baaaaad.” As Public Enemy would say, “Don’t believe the hype!”

Word!

Jason