FedEx Delivers Strong Growth But Misses Expectations

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Despite strong earnings growth in the second quarter, FedEx Corporation (NYSE:FDX) missed consensus estimates. Its earnings per share grew 36% to $2.14, compared to $1.57 a year earlier. [1] However, according to Reuters, analysts expected $2.22 per share. [2] Analysts were expecting significant benefits from a decline in FedEx’s fuel bill due to declining fuel prices, which would translate to higher earnings per share. However, lower fuel surcharge and high aircraft maintenance expenses prevented FedEx from meeting expectations. FedEx also missed on fiscal 2015 earnings per share expectations. The company had reiterated its guidance of $8.50-$9.00 earnings per diluted share, growth of 26-34% from fiscal year 2014. [1] However, consensus estimates stood at $9.12, driven by strong industry growth expectations and declining fuel prices. [2] The market reacted negatively to FedEx’s earnings, pushing down the stock by about 3% at open.

Though FedEx missed consensus estimates, it did deliver a solid performance during the quarter with significant growth in revenue and operating income. Strong volume growth across all segments and profit improvement programs helped drive FedEx’s revenue up by 5%, to reach $11.9 billion, and net profits by 23%, to $616 million. [1]

See our complete analysis of FedEx here

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Missed Estimates On Low Fuel Surcharge, High Maintenance Expense

As expected, FedEx’s fuel surcharge declined due to the falling prices of diesel and jet fuel. The average price of U.S. on-highway diesel fuel, the reference rate for FedEx Ground fuel surcharge, declined 1.9% year-on-year in the 3 months ended September 2014, the reference period for the quarter. [3] The U.S. Gulf Coast spot price for a gallon of kerosene-type jet fuel, the reference rate for FedEx Express fuel surcharge, declined 5.1% year-on-year in the 3 months ended September 2014. [4] The market had expected benefits from the cost savings on the fuel bill to more than offset the decline in fuel surcharge. However, according to FedEx’s press release, there was only a “slightly positive net impact from fuel.”

Fuel surcharge does not vary directly with a change in fuel prices, but remains static over a range of fuel prices. It is possible that FedEx’s revised fuel surcharge, which will be effective from February 2, 2015, will have narrower fuel price ranges and higher surcharge so that its fuel surcharge declines moderate.

In addition to the low fuel surcharge, high aircraft maintenance expense held back FedEx from meeting analyst estimates. Maintenance and repairs expense increased 13% for the quarter due to higher engine maintenance costs for old cargo planes, primarily its MD10s. [5] These maintenance expenses will likely decline after the next quarter.

Strong Volume Growth Drives Revenue, Margins

In the second quarter, FedEx’s revenue and margins benefited from strong volume growth across all segments – Express, Ground and Freight. These volumes primarily included e-commerce related packages, which have been growing due to strong online shopping demand.

Express average daily packages grew 5% on account of strong U.S. domestic package growth, slightly tempered by sluggish International Priority package growth. [1] International Priority package volumes continued to suffer from customers’ shifts in preference towards low price package delivery services. Most of the impact of lower fuel surcharges was seen in this segment, which led to a 2% decline in revenue per package. However, due to profit improvement programs and high volumes, operating income increased 36% and margin by 170 basis points.

In the Ground segment, the moderate decline in SmartPost volumes was a good sign. In the past few quarters, SmartPost volumes have declined in the high single digits to low teens due to the loss of volumes from a major customer. However, in the second quarter the decline was just 4%. [1] Ground service volumes continued to benefit from e-commerce growth, increasing 5% in the quarter. Rate increases, which were effective from the beginning of this year, helped drive revenue per package for Ground by 3%.

Freight segment volume increased 8%, driving the segment’s revenue up by 11%. [1] The high volume also helped increase operating income by 35% and margin by 130 basis points.

Outlook

In the coming quarters, we expect to see continued growth in FedEx’s revenues and margins driven by a change in the pricing mechanism for FedEx Ground shipments, rate increases and recent acquisitions.

  • FedEx Ground will be following dimension-based pricing for all shipments effective from January 5, 2015. Dimension-based pricing, as opposed to weight-based pricing, will lead to better price realization for bulky yet lightweight e-commerce packages, which will significantly improve revenue and margins at FedEx’s Ground segment.
  • In the first quarter of fiscal 2015, FedEx had announced that it will be increasing the rates of all its services by an average of 4.9% effective January 5, 2015. [6]
  • On December 15, FedEx announced that it will be completing the acquisition of GENCO, a leading third party logistics provider in North America. The acquisitions will help FedEx provide its customers with reverse logistics. (Click here to read our article)
  • On December 16, FedEx announced the acquisition of Bongo International, a provider of cross-border enablement technologies and solutions that help e-commerce players reach an international customer base. [7] The acquisition will expand FedEx’s portfolio of products for the rapidly growing e-commerce industry.

We will be updating our model for FedEx after incorporating the quarter’s results.

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Notes:
  1. FedEx Q2 FY 2015 Earnings Release, December 17, 2014, www.fedex.com [] [] [] [] [] []
  2. FedEx Analyst Estimates, www.reuters.com [] []
  3. U.S. On-Highway Diesel Fuel Prices (dollars per gallon), www.eia.gov []
  4. U.S. Gulf Coast Kerosene-Type Jet Fuel Spot Price FOB, www.eia.gov []
  5. FedEx’s (FDX) CEO Fred Smith on Q2 2015 Results – Earnings Call Transcript, December 17, 2014, www.seepkingalpha.com []
  6. FedEx to Increase Shipping Rates for Express, Ground and Freight Services, September 16, 2014, www.fedex.com []
  7. FedEx Expanding Cross Border Enablement Solutions with Acquisition of Bongo International, December 16, 2014, www.fedex.com []