Fedex Margins on Ground Business Growing, Pressure Increasing from International Packages

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In the fourth quarter and full fiscal year, FedEx ground growth and margins remained outstanding, but matching capacity to shifting demand continued to challenge express. Ground logged its 54th consecutive quarter of market share gains, and normalized ground margins tripled those of express. The latter’s troubles stem in part from stagnation in international priority volume (down 2% year over year) even as low-rate international economy demand expanded (up 11%).

Because stuffing long international flights with the economy packages decreases margins, the firm continues to reduce its own airlift capacity and increase its use of third-party carriers (like passenger plane belly space) for international economy packages. However, such shifts take time. Despite the challenges balancing express supply and demand and markets’ downshift to loweryielding products, we maintain our narrow economic moat rating. We’ll incorporate full-year results into our valuation model, but anticipate no major changes to our fair value estimate.

FedEx increased consolidated sales 4% in the quarter, but reported margins contracted to 4.4% from 7.8% in the prioryear period because of business realignment (mostly severance) and aircraft retirement related charges (impairment and accelerated depreciation). Excluding charges, FedEx improved quarterly consolidated EBIT margin to 9.6% from 9.0%. Express, ground, and freight sales grew 3%, 12%, and negative 1%, and adjusted operating margins were 6.6%, 20.1%, and 5.8%, respectively. The firm increased adjusted earnings per share to $2.13 from $1.99 in the prior-year period, and full-year adjusted EPS contracted to $6.23 from $6.59.

The firm continues fleet improvement and margin enhancement efforts. The final Boeing 727 flight is this week; newer, more efficient 757, 767, and 777 planes gradually constitute a greater portion of the fleet. We expect fleet enrichment and other near-term margin improvement actions to weigh on margins and certainly on cash flow. FedEx’s balance sheet bulges with $4.9 billion of cash offset by an increased $3.0 billion in debt. Analysts think cash will fund the voluntary separation packages in the expense reduction plan, aircraft purchases, ground IT and sort facility expansion, and perhaps regular acquisitions.

 

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