On Wednesday, FedEx Corporation (NYSE: FDX ) reported Q3 results for its 2014 fiscal year. Adjusted EPS of $1.23 was flat year over year, and fell 15% short of the average analyst estimate as severe winter weather disrupted operations.
Due to the weaker than expected Q3 profit, FedEx also reduced its full-year guidance. At the end of Q2, the company was projecting 8%-14% adjusted EPS growth for FY14. That translated to a range of $6.73-$7.10. FedEx has now revised its full-year adjusted EPS guidance to a range of $6.55-$6.80.
Despite FedEx's modest profit growth this year, the company's profit improvement initiatives are starting to pick up steam. This should drive an acceleration in profit growth starting this quarter and continuing for the next two to three years.
Cost cuts start showing up
Last quarter, severe winter weather depressed FedEx's operating income by about $125 million. That one-time impact masked the results of the company's ongoing profit improvement program.
In fact, 75% of the employees who accepted voluntary early retirement packages have already left FedEx, with the remainder scheduled to retire by the end of May. The benefits from this side of the cost-cutting program can be seen in FedEx's Q4 guidance for EPS of $2.25-$2.50, which represents 6%-17% year-over-year growth.
Profit growth is likely to accelerate still further later this year and next year as FedEx's aircraft fleet renewal picks up steam. Late last year, FedEx received the first of 50 new Boeing (NYSE: BA ) 767s it has ordered to replace older widebodies in its fleet.
FedEx will use most of its new Boeing 767s to replace MD-10s. The MD-10s have three engines, causing them to consume much more fuel than the 767. In fact, FedEx projects that the 767s will be 30% more fuel efficient and have a unit cost more than 20% below that of the MD-10. FedEx CFO Alan Graf estimates that substituting a 767 for an MD-10 drives a $10 million annual profit improvement.
FedEx is scheduled to remove 36 MD-10s between now and May, 2016. They will be replaced primarily with new 767s, and to a lesser extent with used 757s. Based on Graf's estimate, this alone could add $360 million or more to FedEx's pre-tax earnings. FedEx will also retire a smaller number of Airbus A310s and MD-11s in the next two years, providing additional profit upside.
Waiting for the recovery
The biggest thing preventing FedEx from posting stronger earnings growth is the slow recovery of the global economy following the Great Recession. FedEx's business depends on robust global trade, and it is therefore highly sensitive to global economic conditions.
However, while slow economic growth is holding FedEx back today, this shouldn't concern long-term shareholders. FedEx has been downsizing its aircraft fleet; it is not replacing retiring aircraft on a one-for-one basis, and it is buying smaller aircraft than the models it is retiring. By right-sizing its aircraft fleet, FedEx can improve its earnings even if global GDP growth remains sluggish.
On the other hand, if economic growth accelerates again, FedEx has plenty of flexibility to handle additional package volume. It can increase its fleet utilization, contract with passenger airlines for cargo space on their flights, buy used aircraft that other airlines are replacing, or even buy additional 767s. (Boeing's 767 backlog is minimal.) FedEx is thus well-positioned to profit from the eventual global economic recovery.
So far, FedEx's cost cuts haven't led to rapid earnings growth. However, FedEx will have the full benefit of its headcount reduction in the 2015 fiscal year that begins in June. Additionally, the company is dramatically improving its efficiency by replacing fuel-guzzling aircraft with smaller and more fuel-efficient models.
This will keep profit growing at a steady pace until the global economic recovery gains momentum. Even though FedEx stock is up about 40% since last May, it still looks like a pretty good pick for long-term investors.
More long-term growth picks from The Motley Fool
They said it couldn't be done. But David Gardner has proved them wrong time, and time, and time again with stock returns like 926%, 2,239%, and 4,371%. In fact, just recently one of his favorite stocks became a 100-bagger. And he's ready to do it again. You can uncover his scientific approach to crushing the market and his carefully chosen six picks for ultimate growth instantly, because he's making this premium report free for you today. Click here now for access!