FedEx Earnings Preview: Operating Expenses In Focus

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FedEx (NYSE:FDX) is set to release its fiscal third quarter earnings on March 18th. We will be focusing on the operating expenses for the quarter, since there is a chance that they may have surged as a result of the heavy investments made in order to handle the holiday season package volumes. FedEx could have felt some pressure from the declining oil prices which is likely to temper fuel surcharge revenues.

In the second quarter, strong volume growth across all segments and profit improvement programs helped drive FedEx’s revenue up by 5% to $11.9 billion   and net profits by 23%  to $616 million. [1] Its earnings per share grew 36% to $2.14, missing analyst estimates of $2.22, as lower fuel surcharge and high aircraft maintenance expenses ate into operating profits. The company had reiterated its full-year guidance of $8.50-$9.00 earnings per diluted share, suggesting growth of 26-34% from fiscal year 2014. [1]

See our complete analysis of FedEx here

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Operating Expenses May Surge

FedEx had forecast an 8.8% year-over-year increase in its package volumes for the holiday season between Black Friday and Christmas Eve. [2] In order to handle the packages, FedEx had taken measures which included increasing seasonal workers, using six-sided cameras to read package labels, investing in improving its network and capping deliveries of retailers.

Looking at its significantly improved delivery rates, it seems that FedEx’s preparations paid off. On December 22 and 23, FedEx delivered 99% of the packages on time, compared to a low 90’s delivery rate a year ago. [3] Even on December 24, FedEx managed to reach a delivery rate of 98%, compared to 90% last year. [4]

However, there is a risk that FedEx may have over-invested in its network leading to high operating expenses as was the case with UPS, whose net income declined 61% in its fourth quarter. UPS’ compensation and benefits expenses increased 20.2% as a result of high overtime and training costs for seasonal workers and an increase in contract carrier rates. Also, on days other than expected busy days such as Cyber Monday and December 22, most of UPS’ network remained idle, leading to a decline in productivity.

UPS’ pre-announcement of a decline in profits in the fourth quarter was soon followed by FedEx’s reiteration of its fiscal year expectations, indicating that they are not likely to report a decline as a result of high operating profits. If this does turn out to be the case, it will be interesting to understand what FedEx did differently from UPS to protect its bottom line.

Fuel Prices To Affect Revenues and Margins

In the previous quarter, FedEx’s fuel surcharge declined as a result of the decline in fuel prices. We expect the trend to have continued in the third quarter. Though the decline in fuel prices would have helped reduce FedEx’s fuel bills, the decline in fuel surcharge would have eroded some of the benefit, leading to only a slight net positive impact as seen in the previous quarter.

FedEx Ground’s fuel surcharge is based on the two month lagged average price of the U.S. on-highway diesel fuel, which declined 7.5% year-on-year in the 3 months ended December 2014. [5] FedEx Express’ fuel surcharge is based on the two month lagged U.S. Gulf Coast spot price for a gallon of kerosene-type jet fuel, which declined 24.4% year-on-year in the 3 months ended December 2014. [6]

In order to curb the impact of the declining fuel prices on its surcharge revenue, FedEx recently announced revised fuel surcharge rates. [7] In addition to increasing fuel surcharge rates, FedEx widened the range over which rates remain static. The higher rates and broader ranges will allow FedEx to capture higher fuel surcharge revenue if fuel prices continue to decline. However, the change in rates came into effect from February 2, when more than two-thirds of the third quarter had already passed. Therefore FedEx will likely not see much benefit from the revised fuel surcharge rates in the quarter.

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Notes:
  1. FedEx Q2 FY 2015 Earnings Release, December 17, 2014, www.fedex.com [] []
  2. FedEx Forecasts Record Holiday Volume, October 22, 2014, www.fedex.com []
  3. ShipMatrix: FedEx, UPS deliver 99% of packages in time for Christmas, December 30, 2014, www.fox6now.com []
  4. FedEx, UPS step up their holiday shipping performance, January 1, 2014, www.washingtonpost.com []
  5. U.S. On-Highway Diesel Fuel Prices (dollars per gallon), www.eia.gov []
  6. U.S. Gulf Coast Kerosene-Type Jet Fuel Spot Price FOB, www.eia.gov []
  7. FedEx Feb. 2, 2015, Fuel Surcharge Changes, www.fedex.com []