FedEx Earnings, Margin Pressured, but Guidance Raised

By Lee Samaha Markets Fool.com

The Christmas period is always a pivotal time for package delivery companies, so investors will be wanting to size up the latest second-quarter 2017 earnings from FedEx Corporation (NYSE: FDX) while keeping an eye out on what they might mean for United Parcel Service, Inc. (NYSE: UPS). In that vein, let's take a look at the key facts from FedEx's earnings presentation on Tuesday.

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An alternative delivery method for Christmas. Image source: Getty Images.

FedEx second-quarter results: The raw numbers

Overall revenue increased 19.9%, with operating income up 2.6% in the quarter, but both figures were enhanced by the inclusion of TNT Express. Excluding it, revenue rose 4.7%, but margin contraction led to a drop in operating income of 3.5%.

It's a good idea to break out the numbers by segment. As you can see below, the increase in operating income in the express segment was more than offset by margin declines at ground and freight.

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Segment

Revenue (millions)

Growth

Operating Income (millions)

Growth

FedEx Express

$6,743

2.4%

636

2.3%

TNT Express

$1,899

70

FedEx Ground

$4,419

9.1%

465

(11.6%)

FedEx Freight

$1,597

9.1%

88

(12.9%)

Data source: FedEx Corporation presentations.

Let's look into what happened in each segment in order to understand the quarter.

FedEx Express segment

Starting with the relatively news-free Express segment: Expenses increased in line with revenue, leaving reported margin stable at 9.4%. If there is an overarching theme to the Express segment's results, it's one of increased pricing leading to revenue growth from moderate increases in volume.

For example, Express U.S. package volume actually declined 0.6%, but price increases led to 2.1% revenue growth. Overall Express package volume grew 0.5%, with package revenue growth at 2%. For the Express segment, total composite package yield grew to $19.80 from $19.52 in the second quarter last year.

FedEx Ground

As with Express, Ground saw pricing/yield increases (Ground yield rose 4.1% to $7.95 per package),contributing to revenue growth -- but the segment differed from Express in two ways:

  • Ground segment revenue was supported by strong average daily volume growth of 5% driven by e-commerce and commercial package growth
  • Ground operating expenses increased 12.2% as FedEx incurred costs servicing burgeoning e-commerce growth

In a nutshell, FedEx and UPS are both seeing margin pressure from the increased cost of servicing e-commerce growth. In fact, nearly two-thirds of FedEx Ground's increase in operating expenses came from staffing and purchased transportation -- both driven by dealing with e-commerce during peak delivery season. Incidentally, UPS is also facing margin pressure.

FedEx and UPS are hiking pricing and taking other actions in order to deal with the situation.

Image source: FedEx Corporation.

FedEx Freight and TNT Express

It's early days with TNT Express, but CEO Fred Smith affirmed in the earnings press release that the integration "is proceeding smoothly and according to plan." Meanwhile, the Freight segment continues to battle weak conditions in the transportation industry.

As you can see above, Freight revenue increased 3.2% in the quarter, but a concomitant 4.4% increase in operating expenses led margin to compress to 5.5% in the second quarter compared with 6.5% in the same period last year.

On a positive note, total Freight shipments per day increased 3.8%, but a 1.5% fall in weight per shipment led to flat composite revenue per shipment. While superficially disappointing, the flat revenue per shipment ($232.70) is an improvement on the yearly decline of 3.6% reported in the first quarter of 2017, and suggests the worst may be over for the Freight segment.

Looking ahead

In a sign of confidence, management slightly raised its full-year 2017 earnings forecast. Before pension accounting, fiscal 2017 EPS is expected to be in the range of $10.95 to $11.45 from a previous range of $10.85 to $11.35, representing a 1% increase at the midpoint.

Elsewhere, there are signs the Freight segment might improve, and pricing increases and initiatives should help margins at Express. However, the key question remains how to generate margin expansion in Ground. FedEx and UPS are hiking prices, so conditions should get better in 2017. Moreover, FedEx's CFO Alan Graf said in the release that "network projects are impacting FedEx Ground's near-term profitability," but that the company will "expand capacity, improve service and enhance long-term returns and cash flows." Time will tell.

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Lee Samaha has no position in any stocks mentioned. The Motley Fool recommends FedEx and United Parcel Service. 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.