On Tuesday afternoon, FedEx (NYSE:FDX) reported stellar earnings for the final quarter of its 2017 fiscal year. Ahead of its earnings report, not a single analyst on Wall Street expected FedEx to exceed the midpoint of its guidance range, which called for annual adjusted earnings per share of $11.85-$12.35. (Neither did I.)
Yet FedEx confounded the skeptics with a 29% year-over-year increase in adjusted EPS for the fourth quarter, due in part to tax benefits that analysts may not have expected. As a result, FedEx's full-year adjusted EPS reached $12.30. Furthermore, the company is well positioned to continue its streak of double-digit annual EPS growth in the new 2018 fiscal year.
Digging into the numbers
In the fourth quarter, FedEx's revenue increased to $15.7 billion from $13.0 billion in the prior-year quarter. The majority of this revenue growth came from the new TNT Express segment (acquired last May). But even without that $1.9 billion contribution, FedEx still posted robust revenue growth last quarter.
Meanwhile, adjusted EPS reached $4.25, up from $3.30 a year earlier. FedEx's operating margin declined modestly on a year-over-year basis, mainly because TNT Express is a low-margin business. This factor was more than offset by FedEx's big revenue increase and a lower-than-normal tax rate of around 30%. FedEx quantified the positive impact of tax benefits recognized during the quarter at $102 million, or $0.37 per share.
The tax benefit means that FedEx's earnings report wasn't quite as good as it may have appeared to be at first glance. Nevertheless, it was a big improvement relative to the prior two quarters, when FedEx's earnings fell well short of expectations.
The express segment continues driving profit growth
As has usually been the case lately, FedEx's express segment was the most important contributor to the company's profit growth last quarter. FedEx Express posted a 12.7% adjusted segment margin, up from 11.3% a year earlier, driving a 20% increase in adjusted segment operating income.
Operating income was roughly flat year over year in the freight segment, which was a major improvement compared to the big declines it experienced earlier in the fiscal year.
The ground segment also started to get back on track. Its operating margin declined to 15% from 15.3% a year earlier, following two quarters of severe margin erosion. As a result, segment operating income increased by 7% on revenue growth of 9%.
Finally, TNT Express produced a decent operating margin of 4.4% last quarter, generating a quarterly segment profit of $83 million. Still, it's clear where FedEx makes its money these days. FedEx Express produced a higher segment profit than the three other major segments combined. This highlights the success of FedEx's profit improvement program; just two years ago, FedEx Ground earned significantly more money than the express business.
For fiscal 2018, FedEx expects adjusted EPS to reach $13.20-$14.00. At the midpoint of the range, that would be up about 11% year over year.
Beginning this fiscal year, the company will combine its FedEx Express and TNT Express segments into a single express segment for reporting purposes. The company is sticking to its goal of boosting operating income in the new combined express segment by $1.2 billion-$1.5 billion by fiscal 2020 relative to fiscal 2017. That said, most of the gains are likely to come toward the end of that period, as FedEx completes more of the necessary integration work.
On the downside, investors will have to wait a little while longer for FedEx's expansion and restructuring to drive free cash flow growth. FedEx plans to increase capex to $5.9 billion in fiscal 2018, compared to $5.1 billion in fiscal 2017 (and just $3.5 billion in fiscal 2014).
Fortunately, there's a light at the end of the tunnel. FedEx's capex needs should start to recede after this year. That will pave the way for strong increases in free cash flow thereafter, as FedEx reaps the benefits of its restructuring program, the TNT Express merger, and the steady growth of its ground delivery business.
The Motley Fool recommends FedEx. The Motley Fool has a disclosure policy.