After a couple of somewhat disappointing quarters, FedEx (NYSE:FDX) posted profit growth that soared past investors' expectations last quarter. Following the earnings release, the management team spent some time discussing FedEx's future trajectory and Amazon.com's (NASDAQ:AMZN) recent move into the logistics market. Here are five key highlights that investors should be aware of.
FedEx Express margin improvement on track
Regarding margins, the express profit improvement program will be exceeded by May 31. Express segment margins in the current fourth fiscal quarter will be approximately 12%.
-- FedEx CEO Fred Smith
Back in 2012, FedEx launched a multiyear profit improvement program designed to drive margin growth at its struggling express division. The goal was to achieve a double-digit segment operating margin by the end of fiscal 2016.
There were some bumps early on in the restructuring process, but FedEx is now on track to exceed its goals. In the current quarter -- the last of fiscal 2016 -- it expects FedEx Express to post a 12% segment margin. That would nearly get its full-year segment margin into double-digit territory: something it should easily be able to achieve in fiscal 2017.
TNT acquisition will start paying off in fiscal 2018
... [B]eginning in FY18, I am expecting TNT to be very accretive to earnings. The TNT acquisition is expected to expand our global portfolio, particularly in Europe, significantly lower our cost to serve our European markets by increasing density in our pickup and delivery operations and accelerate our global growth.
-- FedEx CFO Alan Graf
FedEx has secured most of the necessary approvals for its roughly $4.8 billion acquisition of Dutch package delivery company TNT Express. The deal remains on track to close within the next few months.
FedEx CFO Alan Graf noted that FedEx will need to invest heavily to integrate TNT Express after the merger closes. That will weigh on profitability in the next year. However, by fiscal 2018, Graf expects TNT Express to provide a significant contribution to FedEx's earnings, while improving its competitive position in Europe.
Playing the long game at FedEx Ground
We have a number of initiatives under way right now that over the long term will fundamentally change the way we operate FedEx Ground. Now these investments, which vary in timetables but should be essentially complete ... prior to FY21, will have a short-term impact on margin but will ultimately drive cost out of the network, enabling Ground margins to return to historic levels.
-- FedEx Ground CEO Henry Maier
Capital spending has surged at FedEx Ground in recent years. Segment capex totaled $555 million in fiscal 2013. By contrast, through three quarters of fiscal 2016, segment capex has already surpassed $1 billion for the year.
Earlier this fiscal year, FedEx's management stated that FedEx Ground capital spending would peak this year and then decline significantly thereafter. However, the company now sees lots of valuable opportunities to invest in its ground business to increase automation, improve handling of oversize packages, and restructure FedEx Ground as a single network.
The result is that capital spending will remain elevated and Ground profit margins may remain below historical levels for the next several years. But these projects should improve efficiency, allowing for continued growth and a return to higher margins within five years.
Rising cash flow will pay for investments
Our cash flows are such that we can easily fund investments at $4 billion to $5 billion per year while retiring debt used to acquire TNT if the transaction is approved and stock repurchases.
-- Fred Smith
Due to ongoing investments at FedEx Express -- mainly for new aircraft -- and FedEx Ground, FedEx's capex could remain in the $5 billion a year range for the next few years. Yet the company will also have to generate cash to pay for the TNT acquisition and to fund any potential share buybacks over the next few years.
FedEx founder and CEO Fred Smith isn't worried. He expects the profit improvement program and market growth to drive cash flow higher, allowing FedEx to balance all of its capital allocation priorities.
Amazon.com is a partner, not a threat
I'd also like to clarify some of the public discussions and speculation concerning Amazon adding some direct transportation capabilities. First, Amazon is a valuable customer that we've worked with for many years and we expect to work with them for many years to come. ... Large retailers have long had their own transportation capabilities, primarily to enable movement and positioning of inventory across their store and fulfillment locations.
-- FedEx EVP of Market Development Mike Glenn
Finally, FedEx's management team spent some time talking about Amazon.com's recent move to lease its own fleet of cargo planes. Needless to say, FedEx doesn't see Amazon as a threat to its business model. Instead, it believes that Amazon is just following numerous other retailers by developing an internal capability to move goods between various warehouses.
FedEx executives emphasized the advantages in network design, route density, and technology that separate established delivery companies from potential upstarts. As formidable a company as Amazon is, it's still not a significant threat to the package delivery industry.