FedEx Corporation Faces a Busy Year Ahead

The fourth-quarter results from FedEx Corporation (FDX +0.00%) were broadly positive, but the best word to describe them is "noisy." The headline numbers were impacted by a combination of issues including the integration of TNT Express, pricing actions taken to improve yield, and network expansion costs. There is a lot going on in the earnings report; here are the key points.

FedEx Corporation fourth-quarter earnings: The raw numbers

• Fourth-quarter reported revenue increased by 21% to $15.7 billion helped by $1.9 billion from the inclusion of TNT Express. Excluding the acquisition, revenue increased by 6.5%.
• Fourth-quarter adjusted non-GAAP net income increased 28% to $1.15 billion from $897 million in the same period last year, driven by a $152 million increase in the express segment.
• Full-year diluted earnings per share of $12.30 came in at the high end of management's guidance range of $11.85 to $12.35.

Image source: FedEx Corporation.

On a headline basis the numbers were fine, and the headline guidance implies good growth to come:

• Full-year fiscal 2018 EPS guidance, before pension accounting adjustments, of $12.45 to $13.25 implies growth of 1.2% to 7.7%.
• Full-year fiscal 2018 EPS guidance, before pension accounting adjustments and TNT expenses and charges, of $13.20 to $14.00 implies growth of 7.3% to 13.8%. 

What happened in the quarter

The best way to see what's going on is to break out the numbers by segment:

The express segment was the star in the quarter, driven by a combination of higher volumes and yields, while cost management initiatives restricted expenses growth. Consequently, adjusted express margin increased to 12.7% in the fourth quarter compared to 11.3% in the same period last year.

Ground also put in a solid performance. FedEx's e-commerce-related revenue has come under margin pressure -- a challenge that key rival United Parcel Service (UPS 0.01%) is also facing. Both companies have taken pricing initiatives in order to change customer behavior and increase yields. The good news from the fourth quarter was that a 7% increase in yield was accompanied by a 3% increase in average daily volume, leading to a 9% increase in revenue. Moreover, ground margin of 15% in the fourth quarter -- a notable improvement on the 11% reported in the third quarter -- was in line with management's guidance on the previous earnings call.

The relationship between yield and volume is worth looking at in more detail. As you can see below, pricing initiatives helped yields across the board, although investors will want to see express domestic volume increase in future quarters.

In short, it was a good quarter of margin expansion in express and ground, accompanied by good yield growth and solid volumes.

Capital spending and cash flow

UPS has had to ramp up capital expenditures in order to meet the demands on its network from rising e-commerce volumes, and FedEx is having to do the same. Capital expenditures in 2016 came in at $5.1 billion -- slightly lower than the $5.3 billion forecast on the third-quarter earnings call, as some projects have been deferred to 2018.

In fact, capital expenditures are expected to increase to $5.9 billion in 2018 due to extra investments in express fleet modernization and ground network improvements and expansion. 

Looking ahead

As discussed above, guidance for next year implies 10.6% underlying earnings growth at the midpoint. However, it's worth keeping an eye on cash flow, because FedEx's and UPS' need to increase capital expenditures is eating into free cash flow generation. In addition, FedEx needs to execute on the TNT Express integration. FedEx has a busy fiscal 2018 ahead indeed.