Last week, FedEx (NYSE:FDX) reported solid earnings for the final quarter of its 2016 fiscal year. Following the earnings report, FedEx's executive team spent an hour answering questions from the analyst community. Here are five highlights related to FedEx's long-term prospects, its recently completed acquisition of TNT Express, and the company's plans for the coming year.
FedEx has a wide moat
[FedEx Ground has] 37 hubs. The size of these things are 250 acres to 300 acres. They handle tens of thousands of packages. The miles driven by FedEx Ground per year is 1.2 billion miles and Freight is in the same capacity level. So these upstream moats are very substantial...
-- FedEx CEO Fred Smith
For the past few decades, FedEx has faced two main competitors in the U.S.: United Parcel Service (NYSE:UPS) and the U.S. Postal Service. Recently, investors have started to wonder whether a new company could try to enter the parcel delivery business -- or if e-commerce giant Amazon.com could feasibly set up its own internal delivery network.
During the earnings call, FedEx founder and CEO Fred Smith argued passionately that this is not the case. He detailed the huge capital investments necessary to sort millions of packages and carry them between cities. FedEx, UPS, and the post office have this infrastructure. It would probably be prohibitively expensive for another company to replicate it.
Big synergies expected from the TNT merger
I've looked at it now for a lot of months, and they have the best road network in Europe by far. And when you layer all of our international businesses around the world coming into Europe at that efficient, productive, low cost network and you add it to the European network on its own, all of a sudden you start multiplying the benefits and they are very high.
-- FedEx Express President and CEO Dave Bronczek
Up until now, FedEx has lagged DHL and UPS in the European market. The key rationale for FedEx's decision to spend nearly $5 billion to buy TNT Express was to reverse this situation by gaining access to the latter's large European road transport network.
The TNT acquisition has at least leveled the playing field. But FedEx management went further last week, stating that TNT's road network in Europe is significantly better than those of DHL and UPS. Combining that road network with FedEx's strong position in the U.S. and Asia should lead to big opportunities for incremental revenue growth and cost savings.
Investing for growth at FedEx Ground
So I'm not going to sit here and tell you whether Ground's margin is going to go up or down because we're going to just manage to what we think the long-term growth needs of it are here in 2017. But I'm sure that the operating income is going to go up.
-- FedEx CFO Alan Graf
FedEx has been spending huge sums of money to expand its ground delivery network in recent years. Due to the growth of e-commerce, the company sees massive long-term potential in this business.
Between fiscal 2013 and fiscal 2016, FedEx nearly tripled its annual capital expenditures for this segment from $555 million to $1.6 billion. In fiscal 2017, FedEx Ground plans to increase capex yet again, this time to roughly $2 billion. Segment capex is likely to remain at or slightly below that level going forward.
FedEx Ground's aggressive expansion is also putting pressure on operating expenses. This could cause its profit margin to shrink. Nevertheless, management is confident that the segment's operating income will continue to grow. Indeed, in fiscal 2016, FedEx Ground's operating income rose 5% year over year despite 3 percentage points of margin contraction.
Bigger dividends going forward
We've been talking about this for a number of years, how we wanted to be more aggressive in our dividend piece of our shareholder returns. So we picked the 60% increase to try to get it up to a 1% or as close to a 1% yield as we could, which we think is an important milestone.
-- Alan Graf
Earlier this month, FedEx boosted its quarterly dividend from $0.25 to $0.40: a 60% increase. That gives it a dividend yield slightly above 1%.
This isn't especially high by the standards of established companies. That said, FedEx's quarterly payout was just $0.15 in early 2014, so the company has been raising its dividend very quickly recently. CFO Alan Graf suggested that FedEx hopes to continue growing its dividend payout rapidly, as long as it fits with the company's other spending priorities.
Brexit raises new risks
And should Brexit take place, obviously we'll be telling folks what we intend to do to adjust to a new situation. But it's certainly premature.
-- Fred Smith
FedEx's earnings call took place two days before the U.K. referendum on whether to leave the EU. As a result, the company's management declined to speculate about how that might impact FedEx's business.
Now that the U.K. has voted to leave, there is an increased risk of economic disruption there -- which could also spread to other parts of Europe. The timing is unfortunate, given that FedEx just bulked up in Europe by acquiring TNT Express. If Brexit undermines economic growth and trade in Europe, FedEx could face a bumpy road as it integrates TNT over the next few years.