FedEx Earnings: A Robust Quarter Finds No Love From Investors

FedEx Boeing 777 departing the runway in Anchorage Alaska. Source:BriYYZ via Flickr.

FedEx Corporation reported increased revenue and a vigorous rise in net income for second-quarter fiscal 2015 on Wednesday. Revenue expanded by 5% to $11.9 billion, and net income reached $616 million, a 23% improvement from the $500 million recorded in the comparable prior-year quarter. The company's diluted earnings per share also grew handsomely to $2.14, versus $1.57 per share a year ago.

While management reaffirmed current-year earnings guidance of $8.50 to $9 per share, FedEx stock declined during Wednesday's trading session, losing roughly 3.75%, as investors had expected stronger results given an improving economy and falling fuel prices. Was the selling justified? Let's review both the highlights of the report and the factors behind investors' heightened expectations.

A meaningful profit trend continuesBy one important measure, the company's quarter was a resounding success. FedEx is within range of delivering on its promise to raise its operating income margin to double digits in the near future. During the quarter, the company posted an operating income margin of 8.5%, which is also the margin recorded in the first six months of the fiscal year. As we've discussed previously, over the past five years, FedEx produced an average operating margin of approximately 6.5%. Last year the company improved this number to 7.6%.

These incremental improvements on the way to double-digit margins translate into significant profit dollars. For example, on annualized revenue of over $47 billion, the 2% gain in operating income margin this year versus the five-year average is equivalent to nearly a billion dollars of additional operating profit.

Oil is a benefit, not a panaceaPart of the pressure on FedEx's stock on Wednesday was likely due to the minimal impact of fuel cost on the company's profitability. During FedEx's earnings conference call, analysts seemed surprised that the industrial giant had recorded only a marginal boost from lower fuel prices.

The disparity was explained by CFO Alan Graf, who pointed out to analysts that the benefit of favorable fuel prices was partially negated by a reduction in fuel surcharges on customer invoices. It stands to reason that when the price of a gallon of oil rises, FedEx passes the additional cost on to customers by raising its fuel surcharges. Likewise, in periods of declining fuel cost, the company lowers fuel surcharges.

Graf also reminded listeners on the call that the company doesn't purchase fuel daily on "spot market" pricing. Rather, it buys fuel based on global indexes. Roughly three-quarters of jet fuel is purchased on index pricing from the previous week. The other quarter of jet fuel purchase is tied to an index based on the preceding month. So while FedEx has recorded a decent 10% improvement in fuel expense year over year, investors may have let their expectations run too far, charmed perhaps by the recent headlines trumpeting the global crude oil spiral.

Shareholders should note that management did isolate a future benefit from fuel pricing, in that reduced shipping invoices would make higher-yielding, time-sensitive air deliveries more attractive to its corporate customers.

Port slowdowns and the unpredictability of peak seasonIn explaining the factors behind shipping volumes that didn't quite reach expectations, CEO Fred Smith noted that some of FedEx's customers' inventories are being held at West Coast ports because of a labor dispute. Smith predicted that this was an underreported story that would become more prominent once retailers started reporting calendar-year earnings.

Incidentally, as if on cue, McDonald'sannounced on Wednesday that it had stopped selling medium and large fries in Japan, as its blanched potato shipments were being held up in the dispute between port and warehouse workers and the Pacific Maritime Association. You can expect that Smith's forewarning will prove quite accurate over the next few weeks.

Management also revealed that while it had expended resources to handle "peak season" (which begins in November and continues through the end of the year), so far, e-commerce shipping volumes have been softer than expected in the FedEx Ground segment. In other FedEx segments, management described a peak season that is less concentrated around major events like Black Friday and Cyber Monday. The holiday-driven shopping was described as still very active, but spread out over more days than in years past.

"R&M" also cooled earnings momentumDuring the second quarter, total repair and maintenance expense climbed to $543 million, a 13% increase versus the prior year. CFO Graf attributed the variance to maintenance on MD-10 and MD-11 jet engines. For a global shipper of FedEx's size, repair and maintenance is a line item on the P&L that analysts and shareholders expect will be tightly controlled, and composed largely of forward, preventive maintenance. Investors can take comfort in the knowledge that while year to date, "R&M" expense is up 15%, much of this spend has been stacked toward the first half of the year, and is a matter of timing. Repair and maintenance expenditures are expected to moderate in the fourth quarter.

Looking forwardFedEx's revenue and earnings are sensitive to both the domestic and global economy. The company's own economic projections call for U.S. GDP growth of 3.1% during calendar year 2015, and global GDP growth of 3%, both of which are in line with the World Bank's economic forecast. Should these conditions hold despite a number of geopolitical and economic risks, the company may be able to further capitalize on its steadily rising revenue and operating margin. The current macro environment is tougher than it may seem, filled with uncertainties and risks. Are investors discounting FedEx's solid performance? The next several quarters will tell.

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Asit Sharma has no position in any stocks mentioned. The Motley Fool recommends FedEx and McDonald's. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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.

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