Following the earnings report, FedEx founder and CEO Fred Smith and several of his top lieutenants discussed the results and FedEx's business trends with analysts from Wall Street. Here are five key points they emphasized.
Profit improvement program exceeding goals
We will exceed the profit improvement program at FedEx Express this fiscal year, and the aircraft fleet modernization program is paying off in a big way.
-- FedEx CEO Fred Smith
In 2012, following years of margin underperformance for FedEx's express delivery business, the company rolled out a $1.6 billion profit improvement plan. Key aspects of the strategy were efforts to better align capacity with demand, headcount reductions, and the replacement of aging aircraft with newer models that are more fuel-efficient, cheaper to maintain, and more reliable.
This profit improvement plan is scheduled to wrap up within the next year. As of now, the plan is working even better than expected. This has driven strong earnings growth in the FedEx Express segment recently, which should continue for at least a few more quarters.
Soaring peak season demand
[W]e've experienced record-breaking demand during this peak season, largely driven by the rapid growth of e-commerce. Our busiest days during peak have exceeded our forecast and more than double our average daily volume.
-- FedEx EVP of Market Development Mike Glenn
FedEx entered the holiday season expecting a double-digit increase in peak-period shipments. Once again, the growth of e-commerce demand is outpacing even FedEx's relatively bullish forecast.
With rapidly rising peak demand, it's almost inevitable that there will be some snags. In the past month, FedEx has experienced extremely high shipment volumes in the Northeast. But as a whole, the company's deliveries are running on schedule, so there shouldn't be too many late-arriving Christmas presents this year.
Investing in growth at FedEx Ground
We are making significant investments to add additional automated hub capacity and ensure many new stations are also fully automated, providing significant operational flexibility and capacity, particularly during sustained high volume and keeping FedEx ahead of the competition.
-- FedEx CFO Alan Graf
In the past few years, FedEx has increased its investments to support growth in the ground delivery business. In the current 2016 fiscal year, it expects capex for the FedEx Ground segment to total about $1.6 billion.
A few months ago, the company had projected that capital spending requirements would drop significantly next year, to roughly $1 billion. However, due to higher costs for land, equipment, and automation, FedEx now expects ground capital spending to remain steady at about $1.6 billion as it builds the foundation for further growth.
Taking advantage of rising e-commerce demand
Online shopping is a 24/7 experience. So we began a pilot test, which we make weekend pickups at retail locations for Monday residential deliveries in a defined area.
Historically, FedEx Ground's home delivery service has operated five days a week: from Tuesday through Saturday. During the peak season, it has used extra sorting shifts on Sunday to enable Monday deliveries and maximize capacity.
With e-commerce shipment volumes soaring, FedEx is now trying to use a similar system throughout the year. It will do some pickups and sorting over the weekend so that it can deliver some packages on Monday. This will speed up deliveries to customers and allow FedEx to better spread out delivery volume across the week, driving more efficient utilization of its pricey, high-tech sorting hubs.
FedEx began a pilot test of this system in some areas back in May. It has been successful enough that management is now looking to expand the pilot to more markets.
Raising prices to support margins
As we announced in September, we will be raising rates at FedEx Express, Ground and Freight by an average of 4.9% on January 4, 2016. In addition to the rate changes, FedEx also recently increased surcharges for unauthorized packages in the FedEx Ground network.
The downside of this flood of e-commerce shipments is that many of them are packed inefficiently and take up a lot of valuable space on FedEx's delivery trucks. This has put some pressure on FedEx Ground's profitability. Last quarter, the ground segment operating margin of 13% was a little below the long-term target of mid-teens profit margins.
FedEx plans to recover these incremental costs through pricing initiatives. In addition to its normal rate increases, FedEx has also been increasing its surcharges for oversized packages and unauthorized packages (the latter category refers to packages that don't meet FedEx's shipping guidelines, but which the company may accept at its discretion).
By incentivizing e-commerce companies to use more efficient packaging -- and charging more when they don't -- FedEx Ground should be able to bolster its operating margin. That will pave the way for strong profit growth in this key growth business.