FedEx Earnings: Ground Margins Progressing, but Express Profitability Stubbornly Low

Key Morningstar Metrics for FedEx

• Fair Value Estimate: $231.00
• Morningstar Rating: 2 stars
• Morningstar Economic Moat Rating: Narrow
• Morningstar Uncertainty Rating: High

What We Thought of FedEx’s Earnings

FedEx’s FDX top line fell 3% year over year in its fiscal second quarter, driven by ongoing declines in package volume and yield at Express, as well as a soft demand backdrop for Freight’s less-than-truckload operations. Express’ sluggish volume stems from muted retailer restocking, soft global industrial end markets, and lost business from the United States Postal Service, which recently tweaked its delivery strategy. Express yields also saw pressure from normalizing demand surcharges and mix. Overall, revenue came in slightly shy of our expectations.

On the positive side, Express’ yield declines eased, core pricing at Ground seems to be holding up, and Ground volumes rose 1%, helped by share gains from United Parcel Service UPS as customers diverted shipments to FedEx amid the threat of a Teamsters strike.

Express margins missed our profitability forecast (and likely buy-side expectations), declining year over year and sequentially to a paltry 1.7%. We suspect the firm’s air network redesign is yielding structural cost savings, but lost leverage from stubborn revenue declines (including lost USPS business) is proving more powerful so far. We think this will pressure the stock, since it boosts uncertainty surrounding the segment’s longer-term margin potential. On the other hand, Ground’s margin continued to show progress (exceeding our expectations), rising 290 basis points to 10.1%. Freight’s margin also had a solid showing.

We will likely temper our near-term assumptions for Express revenue and margin, but will also probably bump up our margin forecasts for Ground and Freight. Overall, we don’t expect to materially alter our fair value estimate. Shares have jumped over the past year on improving cost execution at Ground, but they’ve recently hovered in modestly overvalued territory.