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Why Investors Need to Keep Their Eyes on FedEx Ground in 2014

Tennessee-based, giant courier FedEx (NYSE: FDX  ) , trusted the world over for its efficient Express deliveries, has been struggling with profitability issues. While the performance of its core Express business failed to impress investors, FedEx Ground posted respectable figures in the latest fiscal third quarter.

Why has the Ground division become the most important driver of growth for the company in recent years? Will its success be big enough to compensate for the slack in the Express segment? As the Ground segment soars high, what's on offer for investors? Let's find out.

The biggest growth driver
Back in the '70s, FedEx pioneered Express deliveries by taking the aerial route. That decision has reaped rich dividends for the company over the years, but nothing is permanent in this world. With rising economic uncertainties, more people are opting for cheaper services; this is eating into Express' revenue and margins. In the first three quarters, revenue remained stagnant and earnings moved only on account of FedEx's cost-cutting measures.

While cutting costs can provide near-term relief, FedEx needs a growth avenue to secure its future -- and the Ground segment fits the bill. The segment delivers small packages to business and residential customers. The division also includes SmartPost, which delivers small packages in bulk and utilizes the United States Postal Service for final delivery.

The Ground business is showing tremendous potential with the increase in demand for e-commerce. It generated more than $10 billion in revenue last year, accounting for nearly a quarter of the company's total sales. Most of the courier giant's incremental sales have come from this segment in the recent past. In fact, the third quarter marked the 57th consecutive quarter of revenue gains.

FedEx has forecast that global e-commerce sales could increase to $1 trillion by 2016, accounting for 1% of the world's GDP. This means that the trend should continue.

Source: 3Q 2014-10Q and 2013 10-K, chart made by the author.

Much-needed profitability boost
FedEx has maintained high operating margins in the Ground segment. In the last three fiscal years, margins have consistently remained higher than 15%, which has helped a lot to offset the weak margins in Express, which dipped to just 2% in fiscal 2013.  

While the size of the Express business is about two and a half times the Ground business in terms of revenue, the latter has generated double the profits of the former in the first three quarters. In fiscal 2013, return on invested capital in the Ground segment was a mind-boggling 18%. Management has said that FedEx Ground's profit margins are the best in the industry.This shows that the growing proportion of Ground segment sales is improving the company's overall profitability.

Source: 3Q 2014-10Q, chart made by the author.

FedEx Ground -- fast and furious
Because it's more oriented toward air-delivery, FedEx has lagged behind its bigger peer United Parcel Service (NYSE: UPS  ) , a market leader in ground logistics. As ground delivery picked up speed in the U.S., UPS gained big time with its highly efficient ground services. Delivering 12.1 million packages through its ground unit in 2013, UPS handled twice the volume  that FedEx Ground moved. But FedEx could prove to be stronger competition with time.

Sensing the enormous potential of the Ground business, FedEx is investing heavily in building capabilities. The company has already made capital expenditures of $609 million in the Ground segment in the first three quarters alone, which exceeds the $555 million spent in the entire fiscal past year.  

Investments have gone into launching and expanding overnight ground services in several new metropolitan markets in order to increase coverage. The company has introduced new hubs with the latest automated sorting technology, expanded the existing ones, and improved other services as well which have increased daily pickup capacity.

FedEx has made significant progress in fast tracking its deliveries, slashing transit times in 4.4% of its lanes. This has given it a good competitive edge. Out of every 100 transit lanes, FedEx and UPS take similar delivery times in 67 lanes, FedEx is faster in 30, while UPS is speedier in three. FedEx has net advantage in 27% of the lanes. These efforts have paid off and the company has increased its market share significantly.

Source: FedEx Roadshow presentation April 2014

The good thing about the Ground segment is that all its services -- FedEx Ground, FedEx SmartPost, and FedEx Home Delivery -- are in demand. The third quarter benefited from market share gains in the home delivery business, which in turn led to an 8% increase in average daily package volume. Yield, which is revenue per package, also increased on account of the January rate hike of 4.9%. Consolidated segment sales improved 10% over last year to cross $3 billion.

Source: 3Q FY2014-10K

Parting thoughts
FedEx is doing the right thing by growing its Ground business. While it's true that the operations may not reach UPS' scale in the near future, FedEx has already gained some competitive edge and the continued market share gains signal a big positive for the segment. The Ground segment's higher profitability comes at a time when the company needs it the most. FedEx can leverage these advantages to keep its growth trajectory intact, while dealing with the pressures in the Express segment.

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Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 15, 2014, at 11:40 AM, mman5513 wrote:

    Would the issue of a non-union shop @ FedEx play heavily into the profit margin? The recent national contract at UPS will have some senior drivers making 100K with OT.

  • Report this Comment On May 16, 2014, at 11:24 AM, ct671 wrote:

    Fedex ground pays no driver health care,pension or holidays because they have non,thats why they can maintain such high profit levels. Fedex hires contractors who then in turn hire drivers for minimum wages with no benefits what so ever.The fedex ground driver who shows up at your house is most likely getting food stamps,subsidized rent and free health care for his family provided provided for free by the tax payer.Most Fedex ground tractor trailer drivers work the same way,pay is a little better but no benefits at all.In most cases pay by the mile or hourly with no time and a half after 40.

    It would only make sense that ground would be their division with the most profit seeing it is the tax payer flipping the bill for their contractual drivers.

  • Report this Comment On May 20, 2014, at 2:16 PM, FUBAR wrote:

    I am a retired FedEx employee, they are one of the top companies in the world. One of reason they are non-union is that they pay their employees well, and treat them fairly, so there is no need for a union. Many contractors for FedEx Ground pay their drivers a good wage and also provide health care, to say that these drivers are on food stamps , subsidized rent and free health care is just untrue.. An over the road line driver for FedEx Ground generates about $43,000 annually, as a FedEx employee. The reason FedEx Ground is the more profitable is that it is run efficiently and the economy is so poor that we are all looking for the most cost effective way to make a living and get by.

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