On Wednesday afternoon, FedEx (FDX 4.26%) reported solid earnings for the second quarter of its 2016 fiscal year. While economic slowdowns in some regions of the world continue to affect FedEx's business, the company's profit improvement plan is still driving strong earnings growth.
The quarter at a glance
FedEx generated revenue of $12.45 billion last quarter, just ahead of the average analyst estimate of $12.43 billion. Adjusted earnings per share reached $2.58: up nearly 20% year over year. Analysts were expecting adjusted EPS of $2.51. The discrepancy between analysts' estimates and FedEx's EPS result was mainly caused by a lower-than-normal effective tax rate.
Looking at FedEx's major business segments, the FedEx Express unit continues to be the main earnings growth driver. While the segment's revenue declined 6% to $6.59 billion because of lower fuel surcharges and the strong dollar, those two factors -- along with good cost management -- also caused operating expenses to decline 9% year over year.
As a result, segment operating income surged 26%, from $492 million to $622 million. This increased the FedEx Express segment margin from 7% to 9.4%, getting the company closer to its goal of a double-digit segment profit margin.
Revenue jumped 32% at the FedEx Ground segment, hitting $4.05 billion last quarter. On closer inspection, this is less impressive than it seems. Most of the revenue growth came from the acquisition of reverse-logistics specialist GENCO -- which generated $373 million of revenue in the quarter -- and a change in how FedEx accounts for revenue for SmartPost packages, which the post office delivers.
Thus, the segment's operating income increased only 13% year over year, reaching $526 million. The FedEx Ground segment margin declined by 2.2 percentage points to 13%, mainly because of the GENCO acquisition and the SmartPost accounting change.
Finally, the FedEx Freight division continues to be the weak link. Segment revenue declined 2% last quarter, to $1.55 billion, and the segment's profit margin declined to 6.5% from 7.1% a year earlier. This caused segment operating income to fall 10%, to $101 million.
Once again, the problem in the freight business was extremely slow volume growth. This meant that FedEx couldn't offset increases in employee salaries and benefits. Unless demand accelerates soon, the company will probably need to implement expense cuts to get back on a path toward double-digit margins in this business.
After cutting its full-year EPS forecast by $0.20 three months ago, FedEx maintained its adjusted EPS guidance range of $10.40-$10.90 this quarter. That represents 16%-22% growth relative to FedEx's adjusted EPS of $8.95 in fiscal 2015.
This strong expected earnings growth indicates that FedEx is still performing well, despite the demand challenges affecting its freight business. As FedEx continues to wring more efficiencies out of the express segment and as it starts to leverage its recent investments in the ground business, profit should continue rising steadily. A turnaround in the freight business would just be icing on the cake for investors.