FedEx (NYSE:FDX) delivered a set of fiscal fourth-quarter earnings on Tuesday that exceeded analysts' expectations, and that should be enough to take the stock higher in the near term. The delivery services giant's earnings are still being negatively impacted by the COVID-19 pandemic, but there are some signs of underlying improvement in its business overall. It was a somewhat complicated report, so let's take a closer look at what it reveals about the company, and focus in on the key metric that investors need to be watching from here.

A quarter of ups and downs

Investors could be forgiven for being confused by the headline numbers from the report for fiscal Q4, which ended May 31. After all, FedEx's overall revenue was only down 3% year over year, but operating income was down a whopping 64%. However, the numbers need to be put into context.

E-commerce deliveries outside a front door.

Image source: Getty Images.

In a nutshell, revenue weakness in FedEx's more cyclical express and freight segments was offset by a pandemic-driven surge in business-to-consumer (B2C) e-commerce shipping, which powered growth in its ground segment. The problem is that B2C deliveries tend to be lower margin. As the table below reflects, ground's 20% revenue increase actually led to a 17% decline in operating income in the segment.

FedEx Segment 

Revenue Q4 Fiscal 2020

Change (YOY)

Operating Income Fiscal Q4 2020

Change (YOY)

Express

$8.560 billion

(10%)

$338 million

(56%)

Ground

$6.394 billion

20%

$673 million

(17%)

Freight

$1.615 billion

(17%)

$132 million

(32%)

Corporate, eliminations and other*

$782 million

(24%)

($668 million)

46%

Total

$16.569 billion

(3%)

$475 million

(64%)

Data source: FedEx presentations. YOY= year over year. *includes acquisition integration expenses and impairment changes. 

The highly unusual nature of the quarter can be seen in the following astonishing chart. Average daily package growth came in at 25% in the quarter, but ground segment margin declined to 10.5% from 15.2% in the year-ago period. Clearly, these shifts can be attributed to the surge in the use of e-commerce after U.S. states put their COVID-19 lockdown measures in place. 

FedEx Key Operating Metrics

Data source: FedEx presentations. YOY= year over year.

The bull vs. bear debate over FedEx

Unfortunately, this earnings report didn't do much to resolve the big bull/bear debate around FedEx stock, and specifically, it didn't clarify much about the margin outlook in the ground segment.

Onlookers who make the bullish case for the stock expect a cyclical recovery in express and freight in line with a gradual improvement in the economy. On the ground side, they anticipate FedEx's higher-margin business-to-business (B2B) segment will recover in due course. Meanwhile, the investments in e-commerce will ultimately lead to margin expansion down the line. From that perspective, the increase in B2C e-commerce volume shouldn't be seen as a negative.

Indeed, during the earnings call, FedEx Chief Marketing and Communication Officer Brie Carere outlined her belief that "the e-commerce change is structural," and went on to say: "I believe that e-commerce will continue to stay elevated, and that will create strong demand for ground for some time in the future."

On the other hand, those who make the bearish case see the margin challenge last quarter as merely a continuation of a trend of rising margin pressure coming from the shift toward B2C deliveries. Bears see this as a structural problem that could get worse as FedEx is forced into an ongoing cycle of investment in order to service more and more low-margin e-commerce deliveries.

Analysts' questions dig into ground margins

As if to emphasize the nature of this debate, analysts asked a series of questions about ground margin during the earnings call. Stephens analyst Jack Atkins wanted to know when FedEx's actions in the ground segment will "begin to yield improved margins and profitability."

FedEx ground margin is key.

Image source: Getty Images.

Chief Financial Officer Alan Graf's response highlighted the fact that FedEx is currently operating at "max peak capacity," the shift to which came upon the company suddenly. As such, it will naturally take some time before it can catch up on the extra incurred costs in its ground segment. In addition, Graf noted that the shift in mix from B2B to B2C had reduced productivity overall, but said: "B2B is coming back."

What all this means for investors

Graf's comments help to draw attention to the key point in the bull/bear debate. Specifically, it's one thing to argue about the direction of B2C margin, and it's another thing to argue about what the mix of B2C to B2B will be in the future.

Indeed, the fact that management didn't give guidance for 2021 speaks volumes about the level of uncertainty out there right now, and that uncertainty extends to just what the mix of B2C to B2B revenue will be. In other words, if FedEx's management can't predict what sources will be delivering revenue, and in what proportions, how can they predict what ground margin will be since that so heavily depends on the mix of sales?

That said, FedEx's management did say that B2B was coming back and as the ground segment gets more used to operating at a high level of capacity, it's reasonable to expect that cost increases will abate. In addition, the B2C/B2B revenue mix surely won't remain so unfavorable. 

As such, FedEx investors should keep a close eye on its ground margins, because if the bullish case is right for this transportation stock, then those margins should start to improve sooner rather than later.