In order to adapt to the rise in e-commerce deliveries and tap into growing global e-commerce demand, FedEx (FDX -1.34%) management has made some costly decisions over the past several months. These decisions have included investments in a residential delivery system, seven-day delivery service, and the purchase of TNT Express.
While the company invests in these areas, this shipping company has seen its financial figures under stress, which has led to some concern from investors. FedEx's second-quarter fiscal 2020 unadjusted earnings fell to $560 million, or $2.13 per share, compared to $935 million, or $3.51 per share, the same quarter a year before -- a total of $1.21 loss per share.
Of course, a few external factors are also at work to dampen earnings. Weak global economic conditions, Amazon's holiday-season ban on using FedEx for shipping (only recently lifted), and the later timing of the Thanksgiving holiday all played a part in lowering FedEx's bottom line.
To better understand FedEx's 3 recent investments and their effects on the business overall, let's take a closer look at each.
1. Residential delivery system
Put simply, e-commerce has changed the way people shop, and therefore how delivery services operate. According to Statista.com, e-commerce sales totaled $3.53 trillion in 2019, and that number is expected to keep growing in the years ahead. For a company like FedEx, embracing this transformation is essential to remaining relevant.
But while shipping companies must make changes to accommodate modern buying habits, this isn't always good for business. Residential deliveries generally cost more and are less profitable than business-to-business deliveries.
Over the last year, FedEx has grown its Ground network to adapt to increased e-commerce deliveries -- and that's led to lower operating margins and profits. According to FedEx's fiscal 2020 second-quarter report, its operating margin dropped from 5.5% to 2.2%, and profits fell 40%.
But these drops seem to be temporary: FedEx management expects its Ground network to see an increase in its marginal profits within this year. "In the fourth fiscal quarter, we forecast FedEx Ground margin [percentages] will again be in the teens," FedEx founder and Chief Executive Officer Fred Smith said during the latest earnings call on December 17. Later in that call, Alan Graf, executive vice president and chief financial officer, shared that the company's "year-over-year adjusted operating profit comparison should improve in Q3 and Q4 relative to Q2."
Investors should watch the next earnings report, slated for March 17, for signs of progress in this area.
2. Seven-day delivery service
The pressure to match Amazon's (AMZN -2.86%) rapid delivery time has many delivery services upping their game -- and FedEx is no different. FedEx officially switched from six days a week of delivery to a full seven-day delivery service in January 2020.
However, that extra delivery day, coupled with the loss of Amazon volume and the shift in holiday sales to the third quarter, led to a 60% margin decline for the company when compared to the same quarter the year before. "Clearly, we didn't do the greatest job of forecasting our cost," Smith admitted during the latest earnings call.
While the initial cost of Sunday deliveries was high, the company stands to gain a lot once the program stabilizes. FedEx rolled out its seven-day delivery service a few weeks early to compensate for increased deliveries during the winter holiday. During the second weekend in December 2019, management saw signs of the program's early success.
"(W)e delivered over 14 million packages on Saturday and Sunday. We weren't even delivering any packages on the weekend a couple of years ago," Smith explained on the December investor call.
Beyond delivering more packages, the seven-day service will also speed up some of FedEx's regular shipping routes by one and two full transit days. Compared to UPS ground service, FedEx is already faster by at least one day in 25% of its shipping routes. Quick shipping routes are especially valuable for shippers and consumers of perishable goods and healthcare items, which provides FedEx with a favorable advantage against its competitors.
3. Acquisition of TNT Express
In 2016, FedEx purchased Dutch delivery company TNT Express for $4.8 billion to boost its international presence and cut network costs.
Unfortunately, the merger is taking longer than predicted. Much of this delay is due to a 2017 cyberattack on TNT's network, which significantly affected its operations and communications systems. Rebounding from this attack has cost the TNT division around $300 million.
Going forward, FedEx believes the amount of business it will gain through this integration (TNT currently ships around one million packages daily) will outshine these setbacks. As FedEx grows its intra-European parcel business, the company will benefit from a lower pickup and delivery cost.
"We remain confident in the long-term strategic value of the FedEx Express/TNT Express combination," said FedEx's President and Chief Operating Officer Rajesh Subramaniam in a press release.
What will happen to FedEx?
In the short term, FedEx's numbers don't look great, and the company has continued to lower its 2020 earnings outlook. The shipping giant expects to earn between $10.25 and $11.50 per share on an adjusted basis for the year, compared to its previous range of $11 to $13 per share.
That said, investors may not need to panic just yet. Most of FedEx's profit loss derived from these so-called "home improvement" efforts, and these negative effects should be temporary.
As noted, FedEx has already seen some success from its seven-day delivery service. However, the benefits of growing its Ground network and integrating with TNT remain to be seen. Investors should pay close attention to both the third and fourth quarter earnings calls, to see if FedEx forecasted its Ground margins correctly. Shareholders should also watch what happens once the TNT integration is complete during the first fiscal quarter of 2022.
If management's predictions prove correct, then now may turn out to have been a great time to acquire FedEx stock. But if its predictions are wrong, then FedEx's share price will sink to even deeper lows. Much is at stake for the company while these upgrades play out -- so investors should expect the recent volatility to continue in the next several months.