FedEx Corporation's (NYSE:FDX) upcoming fourth-quarter results on Tuesday will be eagerly anticipated by investors looking to see if the favorable trends established in 2016 will continue. Like peer United Parcel Service, Inc (NYSE:UPS), FedEx has managed to overcome a slowing global economy and stay on track with its full-year earnings expectations. Can it continue? Let's focus on what to watch in FedEx's earnings report.
It's a good idea to look at these trends in the context of segmental earnings:
The express segment has been the standout performer for FedEx this fiscal year, with segment operating income up 40% in the first nine months. There are two things to look out for in the upcoming results:
- Positive contributions to income and margin from FedEx's profit improvement program
- Yield improvement and margin mix
FedEx CEO Fred Smith expects 12% segment operating margin for express in fourth quarter -- a key metric to watch. The profit improvement plan is a key part of that expectation, but FedEx and UPS are also seeing a favorable change in customer behavior. Since the last recession, customers started shifting preference toward slower, less expensive deliveries -- particularly bad for FedEx express and UPS' premium next-day-air services.
However, as you can see below with UPS, its more expensive next-day-air volumes have been growing nicely in the last three quarters, an indication that customers are more willing to pay for premium services. Moreover, FedEx's management cited yield improvements in express in the third quarter. If these trends continue, then FedEx could see more profit improvement ahead.
Ground grinding it out
Despite a weakening global economy and a slowdown in industrial production-- which negatively affects UPS and FedEx business-to-business (B2B) deliveries -- both companies have seen the following beneficial trends:
- Weak B2B demand is being offset by a strong business-to-consumer (B2C) demand
- Strengthening e-commerce demand is creating growth opportunities for both companies
In this context investors should look out for ongoing strength in both trends. However, burgeoning e-commerce demand also brings about challenges. UPS has had issues dealing with peak demand. In addition, in the third quarter, FedEx CFO Alan Graf outlined plans to increase spending in order to expand capacity for e-commerce growth -- so look out for any commentary on further increases in spending.
Turning to ground margin, Graf expects "mid-teens margins in the fourth quarter." Such figures would mark a return to form for FedEx, because ground operating income fell to 12.6% in the third quarter, partly due to some nonrecurring causes.
The less-than-truckload (LTL) market is likely to remain challenging for FedEx, but investors will want to hear more about how initiatives to improve packaging efficiency -- FedEx is adding dimensional scanners in order to help cost shipments -- are likely to improve profitability in future.
TNT acquisition integration
With the TNT Express acquisition now complete, attention will shift toward the integration and what FedEx management has to say with regard to aligning the TNT European ground network with FedEx's extensive global air network. It's not an easy task because TNT management was already in the process of transforming TNT when FedEx launched its bid.
Finally, UPS and FedEx have both made pricing initiatives in recent years in order to better manage peak demand and encourage customers to package more efficiently. Measures include expanding dimensional weight pricing (packages are charged on dimensions as well as weight), and last quarter Smith announced an oversize-shipment surcharge.
These initiatives are important to maximizing profitability of e-commerce deliveries, and any color on the issue is useful because investors need to see that e-commerce growth can be leveraged into margin expansion.