The third-quarter results from FedEx Corporation (NYSE:FDX) look horrible on a superficial basis, but the devil is in the details, and a deeper analysis shows them to be solid. Moreover, management's outlook contained a number of positive points that should encourage investors. Let's take a look at the numbers from the earnings report and what they mean.
FedEx Corporation third-quarter earnings: The raw numbers
On an adjusted non-GAAP basis, revenue increased by 18.5% to $15 billion while adjusted non-GAAP net income declined 7.8% to $638 million. Revenue was boosted by the addition of TNT Express, and I discuss adjusted non-GAAP income here because it excludes non-recurring items such as the integration of TNT Express, legal expenses, and intangible asset amortization.
In order to see what's going on, it's a good idea to break out revenue and operating income for the main four segments. As you can see below, revenue growth looks good across the board, but steep margin decline in each segment means operating income fell significantly.
|Express||$6.779 billion||3.4%||$586 million||(2%)|
|TNT Express||$1.790 billion||N/A||$40 million||N/A|
|Ground||$4.688 billion||6.4%||$515 million||(8%)|
|Freight||$1.492 billion||3.1%||$41 million||(27%)|
Turning to the reasons behind such a decline in adjusted net income, management highlighted three points:
- A significant negative impact of higher fuel costs -- $735 million compared to $537 million in the same period last year
- One fewer operating day at FedEx Express and FedEx Ground
- Network expansion at FedEx Ground -- in common with United Parcel Service (NYSE:UPS), FedEx is facing margin pressure due to the increased cost of servicing e-commerce growth
It all seems dramatic, but there is little FedEx can do about having one fewer operating day, and it will balance out in the full-year numbers. Similarly, as CFO Alan Graf pointed out, rising (and falling) fuel costs can significantly impact earnings -- as they did in the third quarter -- but "we began adjusting our fuel surcharge weekly instead of monthly for both Express and Ground. This should better match volatility of our fuel expenses to our surcharge."
As for the margin pressure due to e-commerce growth, Graf pointed out that while the investment "dampens Ground's near-term profitability," it will "enhance long-term earnings, margins and cash flow."
Management's positive points
While the quarter was disappointing on a headline basis, there were a number of positives to be taken from it, and particularly from management's outlook. The key points:
- Pricing actions (UPS is taking similar measures) taken to improve yield appear to be working as U.S. Express revenue per package increased 3.1% to $17.36 while overall Ground increased 6.1% to $8.12.
- FedEx Ground segment margin is expected to bounce back to 15%-plus in the fourth quarter from 11% in the third quarter.
- CEO Fred Smith reiterated full-year guidance for EPS in the range of $11.85 to $12.35.
- The TNT Express integration was described as progressing smoothly, with Graf declaring, "We are highly confident in our target and our goals for the Express Group."
- Capital spending forecast for the full year lowered by $300 million to $5.3 billion, which is a net plus for free cash flow generation.
The reiteration of full-year earnings guidance and the guidance on fourth-quarter ground margin were reassuring points in a superficially difficult quarter. That said, the real questions relate to ground margin in future years, capital spending requirements to service e-commerce growth, and the successful integration of TNT Express. Investors will want to see progress on all three fronts.