Most transportation companies are like a proxy for worldwide economic demand, as they transport everything under the sun from raw materials to important documents. One among them is the bellwether FedEx (FDX), which reported rather weak 3Q12 results. Its results took investors by surprise and increased woes regarding the global economic recovery. Despite that, I think FedEx is a good buy right now. In order to clarify my stand, let us take a peek at its 3Q results first.
Although its revenues increased 4% to $11 billion (versus analyst expectations of $10.86 billion), operating income dipped 28% to $589 million. As a result operating margin declined 230bps to 5.4%, the biggest fall in third quarter profit. Integration expenses related to recent acquisitions in Brazil, France, Mexico and Poland also impacted margins. It reported net income of $361 million and EPS of $1.23 compared to the analyst consensus estimate of $1.38.
Reflecting continued pressure from declining international revenues, it guided for 4Q12 EPS of $1.90 to $2.10 and FY13 EPS of $6 to $6.2, which was again below analyst expectations of $2.13 and $6.35, respectively for 4Q12 and FY13.
Delving a little further, the company mentioned that it experienced a tough third quarter as it faced declining profitability in FedEx Express. Decline in FedEx Express was mainly due to the shift towards lower yielding international services and lower international yields. As it faces increased pressure from a large proportion of consumer direct shipments, it mentioned that it would reduce its capacity in Asia and move its traffic towards lower-priced services. As part of its restructuring activities, it will also retire its older and less efficient aircrafts.
Details on its Segment Revenues:
FedEx Ground revenues increased 11% to $2.75 billion and its yields increased 1.9%. Although it posted strong operating margins of 17%, it was lower than 18.8% in the previous year. Further, average daily volume grew 10% driven by growth in FedEx Home Delivery and 26% growth in FedEx SmartPost (due to increase in e-commerce). Its operating margins were lower due to higher purchase transportation and higher network expansion costs.
FedEx Freight revenues were flat while operating margins improved to 0.3%, vs. a loss of 0.1%. Though marginal, but still this was the first profitable quarter for the segment. It continued to leverage the benefits of an integrated network, improved Less-than-truckload (LTL) yield of 2% and improving operational efficiencies.
Turning to the problem area - FedEx Express. Its revenues increased marginally by 2% to $6.7 billion but its operating income declined by more than half to $118 million. Express Domestic package yields increased 2.1% due to rate and discount improvements, followed by increased weight per package. Though volumes increased by 4%, it is facing an accelerating shift towards lower-yielding international services, i.e. customers are preferring lower priced truck or ship services rather than the faster, higher priced air services. In order to mitigate this decline, the company has lined up additional cost-cutting actions for the line haul network, which represents a large portion of its costs for international services. When asked at the earnings call, if the shift was due to trade down experienced by shippers or more of a competitive issue (UPS (UPS) has announced a new product and DHL is getting more expressive), management mentioned that the problem was - "the wrong product on the wrong network." It mentioned that volume was not the issue but overcapacity was the issue.
Initiatives and Restructuring
The company is doing all that it can to maintain its profitability. Its ongoing profit improvement initiatives include aircraft modernization, pickup and delivery productivity, aircraft maintenance processes, and further facilities rationalization.
In an attempt to reduce its costs, in February 2012, the company announced voluntary buyout for its employees. Including the 3Q12 costs, the company now expects the FY13 pretax cost of the voluntary buyout program to range from approximately $450 to $550 million in cash expenditures and some additional costs in FY14.
It reiterated its $1.7 billion profitability program from FY13-FY16 and mentioned that 75% of the benefit would accrue in FY15.
FedEx faces competition from United Parcel Services (UPS) and DHL (Privately held). United Parcel swung to a net loss of $1.75 billion due to a pension-related charge of $3 billion, despite its revenues increasing 3%. Its average revenue per package had declined in 3Q12 as it experienced a problem similar to FedEx. However, in 4Q12, the average revenue per package increased 1.4%. Further, its international export volume increased 5.5%, driven mainly by growth in Asia. DHL on the other hand, continued to post strong growth across its segments and posted a revenue increase of 5.7% in 4Q12. Further, it also announced an increase in its 4Q12 results and expects its positive earnings trend to continue in line with its expectation of earnings increase of 13% to 15% between 2010 and 2015.
Looking at FedEx's results, the question arises whether its customers are migrating to lower margin products due to economic cycle or is it due to a shift in its corporate clients. But the company is doing its bit by investing in long-term projects to drive long-term profit growth.
Despite its weak 3Q12 results and outlook, I would still give it a "Buy" on the basis of its restructuring initiatives, affordable P/E of 15.9, better margins and growth vs. its competitor United Parcel Service.