FedEx Earnings: Weak Economic Conditions Adversely Affect Growth

FedEx (NYSE:FDX) released its earnings for Q1 FY 16 on September 16. The results were weaker than expected, mostly due to poor global economic conditions and the negative impact of currency exchange rates. The EPS for this quarter was posted at $2.42, which fell short of analyst estimates of $2.46, with an operating margin of 9.13%. The adjusted EPS for the same quarter last year was $2.12. ^[1] The company’s Express segment was the saving grace this quarter, whereas the Ground and Freight segments weighed on the top line.

Unlike initially expected, FedEx’s Ground segment failed to shine through, partially due to higher incentive compensation accruals, self insurance, and operating costs. The company’s Freight segment also underperformed, mainly due to lower than anticipated volumes. As mentioned earlier, the Express segment performed solidly this quarter, partially offsetting the adverse impacts from FedEx’s other segments. Despite a fall in revenues by 4%, operating margins in the segment were up 45% this quarter, resulting from higher international export in the U.S. domestic base yield, and lower international expenses due to the stronger dollar.

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FedEx also trimmed its outlook for the full year, down from $10.60-$11.10 to $10.40-$10.90, citing reasons related to higher-than-expected self insurance reserves and operating costs in its Ground segment, along with lower volumes in its Freight segment (this outlook does not include any operating results, nor integration planning and acquisition costs). However, Executive Vice President and CFO, Alan Graf, was quick to reassure investors that the company is looking to deliver at the midpoint level of the guidance range, which would still be 19% up compared to last year, in terms of EPS. Then again, this re-evaluation of the guidance is not absolute and is subject to international growth (particularly U.S. manufacturing) and fuel prices.

Declining Fuel Prices And Adverse Exchange Rate Impacts:

The fall in fuel prices continues to drag-down revenues, as it did last quarter. Fuel prices show no indication of going up in the near future and this has taken a toll on FedEx’s operations, particularly FedEx Express.

The fuel surcharge for FedEx Express is updated every first Monday of the month. It is based on the two month lagged U.S. Gulf Coast spot price for a gallon of kerosene-type jet fuel. After reaching a peak of 11% earlier this quarter, fuel surcharge rates have witnessed a declining trend, with the current rate settling in at 8.5%. Partially because of this, revenues fell by 4%. The other contributing factor was the adverse exchange rates, which led to a decline in the growth for Express’s international export business by almost 1.3%. Unfortunately for the company, this decline outweighed the positive impact of weight, rate, and discount changes. ^[2] To counter this, however, FedEx is ready to increase the fuel surcharges on November 2, 2015.

Weak Economic Conditions:

FedEx management expects moderate economic growth this year in the U.S., as well as globally. However, the main concern was the slower than expected industrial production in the U.S. in the first half of the year. This was primarily due to the strong U.S. dollar (making products manufactured in the U.S. less competitive in the global market), the overall weak global economy and the decline in the oil and natural gas industry. ^[3] The reason this impacted FedEx was because most of the company’s business is generated from business-to-business shipments, which was directly impacted by the slowdown in U.S. industrial production, due to a fall in trade in the first half of CY 15.

Given the way things are at the moment, it is difficult to say which way manufacturing in the U.S. will head. If manufacturing heads upwards, FedEx could see more business, which would positively impact the top-line.

Concerns over China were also addressed in this earnings call. President and CEO of FedEx Express, David Bronczek, stated that China is a big market, however, the business in China is with multinational companies with a global reach (business-to-business shipments), which is why they are largely unaffected by the actual economic conditions in the country.

GENCO Acquisition:

According to the company, FedEx Ground has increased revenues by 29%, partially due to the inclusion of GENCO. However, operating profits suffered slightly due to the inclusion of GENCO’s results. Despite the many benefits that GENCO will provide FedEx, it is expected to weigh on Ground’s operating margin. The reason cited by Alan Graf, is that GENCO is not a business that provides an operating margin in the high teens. Therefore, mathematically, this will negatively impact FedEx Ground’s bottom line even after complete integration.

That being said, however, the management is very happy with how GENCO is doing at the moment, and believe that things are only going to get better.

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1. FedEx Q1 FY16 Earnings Call, nasdaq.com [↩]
2. Fuel Continues to Temper Growth, forbes.com [↩]
3. U.S. Industrial Production Ratchets Up In July, wsj.com [↩]