While the media's attention was firmly focused on the $300 million income hit from a cyberattack, FedEx Corporation's (NYSE: FDX) recent earnings presentations contained a whole lot more useful information for investors. Let's look at the five key takeaways from the earnings and how they might affect the investment thesis behind buying both FedEx and, by extension, United Parcel Service, Inc. (NYSE: UPS) stock.
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Cyberattack impact: more than just $300 million
The impact of the malware attack on FedEx is bigger than just the lost income in the quarter. For example, management expects "ongoing, but diminishing, financial impacts from the cyberattack for the remainder of 2018 in the form of lower revenues and higher investments related to information technology."
The attack was limited to TNT Express, an acquired business that FedEx is currently integrating, and FedEx's management accelerated parts of the integration process in response to events. Consequently, FedEx now expects $350 million in integration expenses in 2018, an estimate $75 million more than made previously.
Indeed, it's worth noting that the impact of the cyberattack on first-quarter EPS was a $0.79 reduction, while Hurricane Harvey was blamed for a $0.02 loss, but the reduction in the full-year EPS, before pension accounting adjustments, was $1.40, to a range of $11.05 to $11.85.
Express segment's midterm targets in place
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While the impact on the express segment from the cyberattack is disappointing, management reassured investors by reiterating expectations for express segment operating income to improve by $1.2 billion to $1.5 billion in 2020 from the nearly $2.8 billion reported in 2017.
The reiteration to 2020 expectations is obviously a positive, but it's worth noting that the impact of the cyberattack is, so far, only $300 million -- in other words, the difference between the top and bottom of the $1.2 billion to $1.5 billion range.
Capital expenditure plans unchanged
FedEx and UPS are both having to increase capital expenditures to accommodate growth in e-commerce-related deliveries, which is pressuring free cash flow growth at both companies. In other words, keeping capital expenditures under control is important for both companies, and FedEx's maintenance of capital spending plans of $5.9 billion, in the face of the cyberattack, is a positive for investors.
Answering a question on the matter during the conference call, CFO Alan Graf said he was "comfortable with that number" and didn't mention any additional pressure for spending on FedEx's ground capacity.
Surging e-commerce volumes are good for volume growth -- FedEx's average daily package volume growth was up 4% in the first quarter -- but it's creating margin pressures. You can see this when looking at a chart of FedEx's ground and UPS's U.S. domestic package segments. Both have experienced margin pressure in the past few years.
FedEx's ground margin fell 70 basis points from 14.2% to 13.5% in the same quarter a year ago:
However, Graf said that "we expect FedEx ground's FY 18 operating income and cash flows to exceed those of FY 17." Essentially, FedEx believes its investments in network upgrading and expansion will lead to increased profits in the future, but for now margin pressure remains.
If FedEx and UPS are going to expand e-commerce-related margin again, it's probably going to need price increases. Both companies have been increasing prices and taking action to ensure profitable growth in recent years.
As such, it's good news that FedEx feels emboldened to increase prices. "[E]ffective January 1, 2018, FedEx Express, FedEx Ground, and FedEx Freight will increase shipping rates by an average of 4.9%," the company stated.
Perhaps FedEx's management is feeling confident on pricing because ground packaging volume and yield are growing nicely together. In other words, previous increases in prices haven't hurt volume growth:
The cyberattack is obviously a negative, and its full implications aren't entirely clear yet, but it's not likely to be a recurring event. However, the issues around profitably managing e-commerce growth are more pressing. The bad news is the pressure on margin hasn't abated just yet. The good news is FedEx and UPS are finding themselves in a position whereby they can increase pricing to try to drive profitable growth. Not many companies can say that right now.
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