For the past several years, I have focused most of my analysis on stock cycles. I first wrote about FedEx (FDX) in a March 15, 2018, article titled "How Far Could FedEx Fall?" In that article, I warned investors about how cyclical FedEx's stock price could be, and that even though it only appeared slightly overvalued at the time given analysts' high expectations, rotating out of FedEx and into Berkshire Hathaway (BRK.B) would be a wise move. I ended up eventually buying FedEx stock on December 20th, 2018, the same day my article "Here's The Price I'll Start Buying FedEx" was published. Here is how the stock fared in between those articles compared to Berkshire, my suggested alternative:
An investor would have been spared from about a -30% drawdown by rotating out of FedEx and into Berkshire when my first article was published.
My thesis when I bought FedEx last December was that the stock had been subject to big downcycles before, and I thought that I was buying it near a cyclical low and also at a deep enough discount to have a margin of safety in case the cycle was deeper than I expected.
In my original FedEx article, I shared this historical price data and analysis:
Some of the key factors current FedEx shareholders might want to consider are the speed at which the stock price could fall, how deep the plunge could be, and how long they might expect the stock to stay below the price at which it is today. Over the past 40 years, FedEx has experienced eight sell-offs of 35% or more as depicted in the table below. In addition to those eight, I also included the most recent 2015 sell-off, which was 33%, because it was recent and very close to 35%:
~Year ~Time to bottom ~Duration ~Depth 1978 3 months 15 months 46% 1980 3 months 6 months 38% 1981 9 months 18 months 39% 1984 4 months 18 months 40% 1987 3 months* 6 years 60% 1997 12 months 15 months 46% 1999 9 months 3 years 45% 2007 24 months 7 years 72% 2015 8 months 18 months 33%
*The stock dropped 50% in the first three months but took longer for that last 10% of the drop.
I think the most noticeable thing in the data is the sheer number of drawdowns over 35% in a relatively short 40-year period. So far, FedEx has had the most frequent drops of any of the stocks I've examined. It's also worth noting, though, that half of them came in the first 10 years. There have been fewer since 1987, but they have also been longer and deeper on average. And if we don't count the very brief recovery the stock made in 1999, then the pattern is more distinct between pre- and post-1987. If we adjust for 1999, the post-1987 period then has recovery periods in between 5 and 7 years if a recession occurs.
The second noticeable thing is the relatively quick drop in price during each drawdown. The market doesn't waste much time punishing FedEx stock if it has any feeling there is an economic slowdown in the forecast.
The third notable thing is that FedEx usually doesn't make and maintain all-time highs for very long periods of time, 1994-1997 was the longest at about 4-5 years. We've already passed four years this time around unless we count the 2015 correction, in which case we're nearing two years.
At the time that I bought FedEx on 12/20/18, the price was well off its highs:
That was comparable to the 1997, 1999, and 2015 drawdowns. As long as the economy didn't slip into recession and FedEx went through a normal cycle, it seemed like a reasonably good bet to make. In my second FedEx article, I backtested the results of the strategy.
The table below shows the results one would have had if they invested after a -40% decline in price during FedEx's previous downturns. The returns in the table do not include dividends. I annualized the returns and then compared them to the S&P 500 if bought and sold on the same dates, annualized. The goal is to see if historically buying after a -40% decline would be an alpha-producing strategy, so the last column is the alpha produced by the investment annualized relative to the S&P 500. All the percentages should be treated as estimates and are based on the approximate months held. If one buys after an ~40% decline and sells after the stock makes a full recovery, it produces an ~67% simple return, so that is the simple return for each of the investments in the table below.
Year the Decline Began Date of Purchase Date of Sale Months Held Annualized Gain S&P 500 Annualized Gain Alpha to the S&P 500 Annualized 1978 10/30/78 9/13/79 11 73.09% 14.67% 58.42% 1984 4/27/84 7/16/85 15 53.60% 17.42% 36.18% 1987 11/30/87 1/20/94 74 10.86% 17.22% -6.36% 1997 9/10/98 12/18/98 3 268.00% 84.80% 183.20% 1999 9/22/99 3/4/02 30 26.80% -4.80% 31.60% 2007 10/8/08 10/15/13 60 13.84% 14.48% -0.64%
During 4 out of the 6 downturns, investing after a -40% decline would have been an alpha producing strategy. However, it would not have been an alpha producing strategy in the 1987 or the 2007 declines.
It should be noted that in the two years the strategy wouldn't have been alpha-producing, it was still a profitable one.
Here is how my FedEx purchase has performed versus the S&P 500 since I bought it on 12/20/18.
In early 2019, FedEx behaved exactly how I expected it to, and even looked like it might start beating the market. Then, it all fell apart.
The shaded green area in the F.A.S.T. Graph above shows FedEx's adjusted earnings over the past 20 years. The past two years saw a 1% gain and a -30% decline. Analysts had expected 16% annual gains for this period when I first looked at FedEx back in 2018. That's a big miss, which is something we might expect during a recessionary downcycle. In fact, the current decline looks awfully familiar to the Great Recession. The only problem, of course, is that we aren't in a recession. And while China's growth has slowed in the past couple of years (not helped by US tariffs) and there hasn't been much global growth, it's not enough to justify FedEx's earnings that we have seen this year. Frankly, they have been a disaster.
Some have been quick to point the finger at Amazon (AMZN) as the culprit, and I think that has certainly played a part. While FedEx bulls are quick to point out that Amazon only represented a small portion of FedEx's business, I think they may be missing something. When someone orders something from Amazon Prime (which I seem to do almost every other day, it seems), some of that is business that could have gone to FedEx if I had ordered from somewhere else on the internet and had it delivered via FedEx. Toss in the trend of in-store pick-up that many retailers are doing now, and that is even more business FedEx potentially misses out on (even if it's not business the company once had and lost). Before in-store pick-up and Amazon, if I wanted anything faster and more reliable than US Mail, I basically had to use FedEx or UPS. Now, I have two more very appealing options. I can simply order from Amazon or order at any number of retailers and pick it up at a store near my house free of charge. That "free of charge" part is an important incentive for consumers. Prime is basically free if you are already a member, and in-store pick-up is simply a matter of someone's time, which many tend to value less than money, which is what they will have to pay FedEx for.
I'm very aware that FedEx is mostly a B2B business, but I'm not sure how much growth is really going to come from there going forward - business-to-consumer seems threatened to me. That doesn't mean FedEx is doomed, but the problem is the company has a lot of leverage and is continuing to borrow.
Going into the 2008 recession, FedEx had $2 billion in debt. Now it has 9x that amount. That's not going to augur well for the company when we have our next recession, which could be sooner rather than later. This is something I should have noticed last December but didn't, and that was a mistake on my part.
Typically, I have four different types of articles that I write for cyclical stocks, and they generally have the same style of title so that I can keep track of them. When I think a cyclical stock is near its peak, I write a "How far could they fall?" article where I warn investors about the dangers of the stock and suggest alternative investments that won't fall as much. Then, when a stock falls about -20% off its highs, I write a "Here's the price I'll start buying" article. These share two entry points for the stock that would have been good to buy historically, and I backtest those entry points. Typically, a stock still has further to fall before it hits those entry points. The third type of article are "buy" articles, where I announce that I have purchased a stock. In these articles, I run the business through a series of what I call "impairment tests". These are a list of things that I look for that might be different this time than previous cycles which might impair a recovery. If a stock passes the impairment tests, I buy it at this point, and if it doesn't, I share why I'm passing on the stock (I did that with 3M (MMM) last year). And lastly, I write an article when I sell the stock - like this article - which reviews the results of my investment or trade so others can potentially learn from my victory (like my recent Micron (MU) article) or my mistakes.
FedEx ended up being a little different than most stocks, and it caused me to cut corners regarding my impairment tests. What happened was, in the two days from which I submitted my "Here's the price I'll start buying FedEx" article to the time it was actually published, the stock price fell so much that it hit my buy price. If you will recall, this time in late December 2018 the market was falling rapidly. I was writing articles every single day either telling investors they could now rotate back into stocks I had suggested they rotate out of, or I was writing "buy" articles. In fact, I bought more than I could write about at the time. I bought Roper Technologies (ROP), Equifax (EFX) and more Apple (AAPL) on top of everything else I was buying, and I never even had time to write articles on those. So, it was a frantic time of buying, and I bought FedEx quickly and noted it in comment section of my 12/20/18 article (I didn't want to write a new article the very next day after I had just written one), but the mistake I made is that I didn't fully run the stock through my impairment tests.
One of those tests is to check debt-to-equity this cycle compared to previous cycles.
If I would have done that, I probably would have passed on the stock. The debt-to-equity, even back in December 2018 when the chart above ends, was double to quadruple what it had been during previous cycles. This is something I should have noticed but didn't in my haste to buy at a cheap price.
My Original Thesis is Broken
It's important to stress here that I am the type of investor who tends to sell when others are buying and buy when others are selling. FedEx is an example of that. When the price was just off its all-time highs, I was bearish on the stock. And when the price fell dramatically last December, I did not hesitate to buy it. Now, when one looks that the sentiment of Seeking Alpha writers on FedEx, it is mostly bearish. It's rare that I join them, and I could very well be wrong. FedEx might have a plan here, and maybe China tariffs and a global economic slowdown were enough of a one-two punch to temporarily dent the company's business, Amazon is no threat, and FedEx will soon recover. However, I didn't buy FedEx stock as a turnaround play at this time last year. I bought it as part of a normal cyclical downturn and expected recovery. This doesn't seem like a normal cycle to me, and the difference in debt load this cycle compared to the last recession is enough to make me not want to hold the stock through the next downcycle. FedEx might end up being okay, but my thesis is broken in the sense that this cycle is simply not similar enough to previous cycles. We have both disruption going on and higher debt.
I am fortunate that I bought with a good margin of safety. In fact, in the comment section of my original March 2018 article, I stated that I wouldn't likely buy FedEx stock until it was around $160-165, from just glancing at the numbers. At the time, the stock was trading at $247, and $160-165 turned out to be a reasonable price to place a bet on the stock. Because I was willing to wait for a margin of safety, I won't be losing much on this bet even though I made a mistake. Hopefully, this serves as a reasonable example of why a margin of safety is important.
While I'm currently long FDX, I plan to sell my shares just after the new year. This doesn't appear to be a normal cycle from what I can see here. It might end up being a temporary decline, but it doesn't feel that way to me. It looks like a value trap to me, especially if we have a recession within the next two years, in which case, FedEx will have even more headwinds to deal with. If that happens, there could be tremendous downside for shareholders that they might not recover from for many years.