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Looking for Improvements at FedEx

By Adam Levine-Weinberg - Sep 16, 2013 at 6:07PM

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FedEx is expected to report Q1 results on Wednesday. Has this global shipping giant finally turned the corner?

The Great Recession was not kind to global shipping giant FedEx (FDX -2.42%). Whereas the company's Express division typically posted an 8%-9% operating margin prior to the recession, customers have increasingly tried to cut costs by using slower shipping methods. As a result, FedEx Express' adjusted operating margin plunged to 5% in fiscal years 2011 and 2012 and just 3.9% in the fiscal year that ended in May.

A FedEx truck makes deliveries.

FedEx set out on an ambitious cost-cutting campaign last year in order to reverse this margin decline. However, investors were not satisfied when management projected that FY14 earnings would rise just 7%-13%. Many analysts think that the company lowballed its guidance, so the average estimate for full-year earnings implies growth near the top of the guidance range.

This week, FedEx is on deck to report earnings for the first quarter of fiscal year 2014. The company is also expected to update investors on its annual outlook. Investors should be looking for Q1 earnings to improve by at least 7% (the bottom of the full-year guidance range). A boost to the full-year guidance would also be a bullish sign.

Profit improvement initiatives
FedEx's profit improvement actions started to have a positive impact in the fourth quarter of fiscal year 2013 due to cost-cutting measures earlier in the year. Q4-adjusted EPS improved 7% year over year to $2.13. The company achieved strong growth in the FedEx Ground segment while cuts in costs boosted margins in the Express business.

Moreover, FedEx implemented a number of cost-cutting moves after the quarter ended. First, employees began leaving under the company's voluntary early retirement program at the end of the fourth quarter. Approximately 40% of the 3,600 employees (or 1,440) who accepted buyouts left the company on May 31. (Another 35% will leave during the current fiscal year, and the last 25% will retire on May 31, 2014.)

Secondly, FedEx reduced Express capacity between Asia and the U.S. again in July in order to better match capacity to demand for priority shipments. Lastly, FedEx has continued to retire older, inefficient aircraft. In June, FedEx finally retired its last Boeing 727, a 1960s-era airplane with three engines (modern aircraft of that size only need two) and a flight crew of three (modern aircraft only need two pilots ).

Moving forward
The key question for investors is whether these cost-reduction efforts will be enough to offset a relatively weak macro environment. The average analyst estimate calls for a 4% increase in earnings per share to $1.51, but FedEx's cost cuts create some upside to that number.

Looking forward, demand may pick up in the second quarter due to the launch of new electronics products that FedEx will ship from Asia to the U.S. and other markets. For instance, FedEx handles express shipments for Apple's (AAPL -0.45%) iPhone, according to Bloomberg. Apple charters FedEx Boeing 777s -- which can carry approximately 450,000 iPhones -- for direct flights from China to the FedEx hub in Memphis.

Since Apple could easily sell 20 million or more iPhones in the U.S. between now and the end of the calendar year, this represents a significant revenue opportunity. Therefore, investors should pay close attention to FedEx's outlook and commentary on the business environment, as well as first-quarter results.

FedEx currently trades for about 16 times fiscal year 2014 earnings estimates. If the company's profit improvement plan seems to be on track, that could be a great bargain. FedEx executives expect the bulk of the company's cost savings to hit the bottom line next year, which should lead to strong profit growth, especially if global economic growth picks up.

Fool contributor Adam Levine-Weinberg owns shares of Apple and is long January 2015 $390 calls on Apple and long January 2015 $100 calls on FedEx. The Motley Fool recommends FedEx. It recommends and owns shares of Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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