FedEx Earnings Preview: SmartPost And Express May Present Headwinds

FedEx (NYSE:FDX) is set to release its first quarter (fiscal year ending May 31) earnings on September 17. In the fourth quarter, its revenue grew 4% year-over-year to $11.4 billion, driven by revenue growth at FedEx Ground and FedEx Freight. ^[1] Its net income grew a staggering 141% due to adjustments made to FedEx’s Express segment in the fourth quarter of fiscal year 2013 which led to zero net income from the segment. ^[2] These adjustments included business realignment and impairment charges. The high net income and repurchase of 9.9 million shares of FedEx common stock during the quarter helped drive up earnings per share by 159% to reach $2.46.

During their fourth quarter earnings meet, FedEx announced its guidance of $8.50-$9.00 earnings per diluted share in the fiscal year 2015, a growth of 26%-34% from fiscal year 2014. ^[3] FedEx had recently increased its quarterly dividends by 33% citing strong cash flows during the fourth quarter. ^[4]

For the first quarter, we expect to see continued growth at FedEx’s Ground segment driven by e-commerce volume growth. However, loss of volumes from one customer for FedEx’s SmartPost service will be a matter of concern. Additionally, a shift in demand towards low-priced services may continue to impact FedEx’ Express segment.

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E-commerce and rate increase will likely drive FedEx Ground

Similar to the previous quarter, we expect to see FedEx’s Ground service to grow driven by the strong e-commerce market. E-retailers prefer using cheaper means of shipping their products so that they may pass on the benefits of low costs to their customers. Many e-retailers are able to offer free shipping service because of the low shipping cost incurred by the e-retailer. In the fourth quarter fiscal year 2014, FedEx’s Ground service volumes increased 8% due to the booming e-commerce market. With the e-commerce market forecast to grow 20% in 2014, ^[5] we believe FedEx’s Ground service should continue to grow in the first quarter fiscal year 2015.

For the fiscal year 2015, we believe that the new dimensional weight pricing mechanism, which will be effective from January 2015, will have a major role to play in FedEx’s Ground segment. The new pricing mechanism will not only help growth in revenue but also help improve margins due to better price realization.

SmartPost volumes may present headwind

In the fourth quarter of fiscal year 2014, revenue from FedEx’s SmartPost service, which uses the services of the U.S. Postal Services to make final delivery to any residential address or PO Box in the U.S., declined 2% due to an 8% decline in volumes. This decline was primarily the result of a change in shipping patterns from one large customer. ^[3] Excluding the volume from that customer, SmartPost volume increased 15%. This customer, whom FedEx has not named, had decided to directly use the U.S. Postal Services instead of using SmartPost.

FedEx’s management believes that they will be able to replace the lost volume. However, they did not outline any plans that have been set in place to do so, which makes us believe that SmartPost volumes may decline in the first quarter as well.

Express margins may remain under pressure due to shift in customer preference

FedEx’s Express segment margins have been under pressure due to the shift in customer preference towards low-priced deferred delivery services. The unfavorable volume mix arising out of higher volumes of low-priced service packages leads to a decline in overall margins since these services command lower revenue per package. In the previous quarter, the U.S Deferred service average daily volume grew 7% whereas U.S. Overnight volume grew only 1% after being negatively impacted by an 8% decline in U.S. Overnight Envelope service. Combined with a similar trend in international package volumes, FedEx Express’ margins in the previous quarter declined 6%. For the full fiscal year 2014, it declined 5%. ^[1] We expect to see the decline in margin to continue into the first quarter.

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1. FedEx Q4 Earnings Release, June 18 2014, www.fedex.com [↩] [↩]
2. FedEx Q4 Stat Book, June 18 2014, www.fedex.com [↩]
3. FedEx’s (FDX) CEO Fred Smith on Q4 2014 Results – Earnings Call Transcript, June 18 2014, www.seekingalpha.com [↩] [↩]
4. FedEx Corp. Announces Increase in Quarterly Dividend, June 9 2014, www.fedex.com [↩]
5. Worldwide Ecommerce Sales to Increase Nearly 20% in 2014, July 23, 2014, www.emarketer.com [↩]