FedEx Corporation (NYSE: FDX) stockwas down a few percentage points after the company released its fiscal second-quarter results. In short, investors appear to befretting over margin contraction in the quarter,caused by increased investmentin the ground segmentto prepare for e-commerce growth. That said, let's take a closer look at what went on by looking at five key takeaways from the earnings call.
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E-commerce is fueling FedEx Corporation's growth, but it requires capital investment too. Image source: Getty Images.
Peak delivery season is going well
Given that earnings were released on the 20thof December, it's a perfect opportunity for management to outline performance during peak delivery season. Although key rival United Parcel Service (NYSE: UPS) has borne the brunt of the difficulties in previous years, there is no telling exactly how peak demand days will pan out in any given Christmas holiday for either company.
Fortunately, FedEx's CEO Fred Smithhad positive things to say: "[W]ith the exception of several local weather issues, our service levels have been outstanding." Moreover, Smith went on to outline how FedEx's traffic mix "is a bit different by design" due to the company's "commitment to continue to grow earnings."
The latteris a sign that FedEx is achieving its aim of influencing customer delivery patterns during the peak delivery season, and in doing so is helping FedEx optimize profitability. UPS is trying to do a similar thing.
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Ground segment takes a hit, but will improve
FedEx's earningsshow how the company was hit by margin contraction in the ground segment. Essentially, FedEx recently opened four new hubs and 19 automated stations largely to facilitate growing e-commerce delivery demand.
Naturally, analysts asked questions on that topic. Smith allayed their fearson the possibility of ongoing margin contractionin three ways:
- Investments are being made to support Smith's "firm belief" that FedEx ground volumes will grow
- Ground margin is likely to increase as more volume starts to flow because the marginal cost is "shockingly low" at automated facilities
- Smith predicted that ground volume, revenue, and margin would "go up" in fiscal 2017, and "certainly" in fiscal 2018 too
Customers across all segments
On almost every earnings call, FedEx's management stresses that the company isn't run with one quarter's margin in mind, and certainly not with one segment's margin in mind. In other words, the business is run with a strategic mindset. In this regard, Smith's declaration that 92% of revenue in the U.S. comes from customers who use both express and ground services was particularly insightful.
It suggested that it isn'tfeasible for FedEx to avoid investing in one segment or the other in order to massage margin in the future -- a holistic approach is necessary, and investors should understand the extra investment in the ground segment in this context.
Express will have a good year
With nearly all the analyst emphasis on ground margin, it was easy to forget that the express segment was responsible for slightly more than 50% of segment operating income in the quarter. Indeed, a quick look at express segment volumes reveals a decline in the U.S. in the second quarter.
Data source: FedEx Corporation presentations. Chart by author.
CEO of FedEx Express David Bronczek claimed it was down due to Hurricane Matthew and a typhoon that hit the west coast, and Smith argued that a single customer decided to move volume out of the peak quarter, while CFO Alan Graf suggested analysts would be "pleased" by how the express segment will finish the year -- something to look out for.
TNT Express on track
Finally, Graf claimed the TNT Express integration "continues to proceed as planned," with $750 million in annual pre-tax synergies expected to be achieved in 2020, having spent a total of $500 million in capital expenditures on TNT in total, with $100 million in fiscal 2017. The total program expense is expected to be in the range of $700 million to $800 million over the next four years.
Integrating TNT Express is a key part of FedEx's 2017, and it's good news that plans remain on track.
All told, the margin hit in the quarter seems to have hit the stock price in the near-term, but it will all be forgotten if volumes flow through as planned in the ground segment. Management expects margin expansion in ground in fiscal 2017, and implied that express volumes will improve going forward.
If FedEx can achieve these aims while undergoing a stress-free integration of TNT Express, then 2017 is set to be a good year for the package delivery giant.
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