Prepared by Tara, Senior Analyst at BAD BEAT Investing
We have been bullish on shipping names in recent weeks following the uptick in online shopping thanks to the stay-at-home trends produced by COVID-19. FedEx (NYSE:FDX) is a primary play in this space. Shares have been on the mend since spring and the COVID-19 selloff, and the future looks bright. We think this is a fine long-term play.
FedEx has had a number of questionable quarters in recent years, and this has helped keep the pressure on shares compared to where they were a few years ago. However, with the most recent quarter having been reported a few weeks ago and today's Amazon (AMZN) Prime Day looking like it will set records, we think FedEx has legs higher. We like what we see here.
Why? Well, the company has just reported a solid set of results. Admittedly this was a tough quarter to handicap but looked strong, while expectations were all over the place. While it was largely expected that sales would be about flat, the consensus expectations were exceeded handily. We believe this is bullish, and with today's Prime Day, shippers should continue to do well as we move into the holiday shopping season.
Sales crush expectations in Q1
It was widely expected that sales would be about flat thanks to a tough start to Q1 with improvement over the summer. Well, revenue was $19.32 billion, rising a big 13.3% year over year and beating estimates by $1.7 billion. These revenues of course rose from the $17.1 billion a year ago. That was a strong positive we thought. Performance was of course affected by the COVID-19 pandemic impacting all revenue and expense line items during the quarter. While commercial volumes were down significantly due to business closures across the globe, there were surges in residential deliveries that really drove this better-than-expected number, and strength in international activity as well.
Margins better than expected leading to stronger-than-expected earnings
On a GAAP basis, reported earnings were $4.72 per diluted share for the fiscal first quarter compared to a gain of $2.84 per diluted share last year, so that is a strong improvement. Of course, we need to consider adjustments when comparing year over year and as such adjusted operating income was positive, coming in at $1.64 billion, and this was up big from $1.05 billion last year. This result saw a benefit from operating margins of 8.5%, well above consensus in the mid-6% range. Adjusted earnings were $4.87 per share, crushing expectations by $2.15.
The growing divergence in segment performance was notable. Segment-specific results were very telling. We thought that commercial volumes would be down a touch due to business closures a bit across the globe but not nearly as poor as we saw in fiscal Q4. But we also saw big increases in residential deliveries at FedEx Ground and in transpacific and charter flights at FedEx Express. Of course, these have associated costs to serve customers.
One source of ongoing costs has been the TNT Express integration. This is a multi-year process. We think that you can continue to expect that FedEx will have a lot of expenses for the next two years as the company continues the integration of TNT Express. It is expensive.
Many of the adjusted metrics reported adjust for the significant TNT Express integration expenses. These adjustments are made as the expenses aren't part of the so-called normal operations.
They include professional and legal fees, salaries and employee benefits, travel and advertising expenses. It is expected that the company will continue to see some pressure on GAAP results thanks to this. So it is something to keep in mind going forward.
Looking ahead
The COVID-19 disruption appears to have had a mixed impact on operations. We believe the stay-at-home trend will continue this year, and that will benefit the residential deliveries that have spiked. Operating results in Q1 increased due to volume growth in FedEx International Priority and U.S. domestic residential package services, yield improvement at FedEx Ground and FedEx Freight but were partially offset by costs to support strong demand and to expand services, variable compensation expenses, and COVID-19-related costs incurred to ensure the safety of FedEx employees. That said, we expect the Q2 and Q3 to see similar benefits that Q1 saw thanks to COVID. We think Prime Day will be a good read for shippers and a proxy for possible holiday action. The company did not provide an earnings forecast and truthfully it is very tough to see where things are going but we have bullish estimates for this year. We believe fiscal 2021 revenues will come in between $76-80 billion, and EPS should be in the $16.25-18.50 range. This puts the stock in the 16-X18X forward EPS range, which is not overvalued in our opinion. We think the stock moves higher.
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