FedEx Earnings: Fuel Continues To Temper Growth

FedEx (NYSE:FDX) released its fiscal fourth quarter earnings on June 17. The company’s stock declined 2% during pre-market trading as it missed market expectations for revenue and earnings per share. FedEx’s fourth quarter revenue grew a sluggish 2.5% year-on-year, to reach $12.1 billion, missing the consensus estimate of $12.3 billion. ^[1] The company’s adjusted earnings per share grew 4.7%, to reach $2.66, marginally below the consensus estimate of $2.68. Adjusted earnings per share excludes the impact of change in pension accounting and segment reporting, impairment of aircrafts and an increase in legal reserve.

On a non-adjusted basis, FedEx’s earnings per share came in at a loss of $3.16. The primary reason for the negative earnings was the adoption of mark-to-market pension accounting for its defined benefit pension and other postretirement plans, which led to a non-cash charge of $4.88 per diluted share. ^[1] Aircraft impairments also resulted in a non-cash charge of $246 million, or $0.62 per diluted share.

FedEx’s fourth quarter revenues were driven by high volumes and pricing initiatives. However, low fuel surcharge revenue and foreign currency headwinds tempered growth. The company’s net income was flat at $753 million, due to the same factors.

For the full fiscal year 2015, FedEx’s revenues grew 4.2%, to reach $47.5 billion. Adjusted net income increased 17.3% as a result of a 110 basis point improvement in operating margins, which was driven by higher volumes, new pricing initiatives and profitability improvement programs. Earnings per share for the full fiscal year increased 27%, to $8.95, tracking the upper end of the company’s revised guidance.

FedEx expects its adjusted earnings for fiscal 2016 to grow to $10.60-11.10 per diluted share driven by an increase in base pricing and continued benefits from profit improvement program such as aircraft replacements. The guidance does not include any impact from the TNT acquisition. FedEx expects its capital spending to be approximately $4.6 billion for fiscal 2016.

See our complete analysis of FedEx here

Net Negative Fuel Impact Tempers Revenue And Profits

FedEx’s revenues benefited from strong volume growth in all three segments – Express, Ground and Freight – partially offset by lower fuel surcharge as a result of the declining fuel prices.

FedEx Ground’s fuel surcharge is based on the two month lagged average price of the U.S. on-highway diesel fuel, which declined 26.3% year-on-year in the 3 months ended March. ^[2] Despite this, ground revenue per package grew 2% driven by the increase in base rates and dimensional weight pricing charges, which were effective from the beginning of 2015. ^[1] Rates of all ground services were increased by an average of 4.9%. ^[3]

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 three months ended September 2014. ^[4] Express revenues declined 4% as a result of the lower fuel surcharge and weak foreign currencies, which completely offset the benefits of an increase in base rates and growth in volume.

Unlike the previous quarter, where a decline in fuel surcharge revenue was more than offset by a steeper decline in fuel expenses, FedEx’s fourth quarter fuel surcharge decline was heavier than the drop in its fuel bill, leading to a net negative impact from fuel. The quarter’s fuel bill declined 36% year-on-year, which helped operating margins grow a sluggish 20 basis points.

GENCO Acquisition Boosts Ground Revenues But Tempers Profits

GENCO, the third party logistics provider that FedEx had acquired in January, helped boost Ground revenues, which grew 19% year-on-year in the fourth quarter. Higher volumes and dimensional weight pricing also contributed to the growth. However, as a result of the low-margin GENCO business and related integration expenses, the segment reported a 3.1% drop in operating margins.

GENCO is likely to continue weighing on operating margins until the time it is fully integrated into FedEx’s Ground segment, which should be in around 12 to 18 months. FedEx’s decision to integrate SmartPost with Ground, effective from September, will also have an impact on operating margins since SmartPost is a low margin service. ^[5] However, this move should not impact net profits or cash flows. FedEx expects to see significant synergies by integrating SmartPost and Ground through maximized use of facilities and manpower. This should help bring down operating expenses and capital expenditure. However, these benefits will likely be realized only by fiscal 2017.

Outlook for Fiscal 2016

FedEx’s guidance of $10.60-11.10 earnings per diluted share stems from the expected growth driven by base pricing improvements, volume growth and profit improvement programs. However, foreign currency headwinds and net unfavorable fuel impact will continue to temper growth. Higher incentive compensation accruals will likely impact results as well. FedEx’s plan to increase capital spending to $4.6 billion in fiscal 2016, compared to $4.3 billion in fiscal 2015, will also temper cash flows. However, since most of this will be invested in the Ground segment, which has been growing rapidly on e-commerce volumes, it is likely to yield higher returns.

It will be interesting to see how FedEx’s profitability improvements programs will pan out in the year. One of the major profitability improvement programs undertaken by FedEx includes replacing old inefficient aircrafts. FedEx recently announced that it has expedited the retirement of aircrafts and related engines, which will likely be replaced by new aircrafts with greater efficiency. ((FedEx Corp. Accelerates Aircraft Retirements, June 1, 2015, FedEx News Release)) Each such replacement can boost the company’s bottom line by $10 million. ^[6]

TNT Acquisition Update

On the earnings call, FedEx informed that it will be submitting initial offer documents, as required by Dutch law, by the end of the month. ^[5] The company is confident that the transaction will not run into competition issues with the European Competition Commission. We believe that with the way things are moving forward, the acquisition might be completed by next year.

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1. FedEx Corp. Reports Fourth Quarter Earnings, June 17, 2015, FedEx News Release [↩] [↩] [↩]
2. U.S. On-Highway Diesel Fuel Prices (dollars per gallon), www.eia.gov [↩]
3. FedEx to Increase Shipping Rates for Express, Ground and Freight Services, September 16, 2014, www.fedex.com [↩]
4. U.S. Gulf Coast Kerosene-Type Jet Fuel Spot Price FOB, www.eia.gov [↩]
5. FedEx (FDX) Frederick Smith on Q4 2015 Results – Earnings Call Transcript, June 17, 2015, Seeking Alpha [↩] [↩]
6. FedEx: Fleet Retirement Keeps 10% Margin Target in Sight, June 2, 2015, www.barrons.com [↩]