Summary
Our first review of the FDX 10-K did not reveal anything new of great relevance. There is some additional discussion of the restructuring, but no new specifics that we saw. The language around “independent contractors” or “owner-operators” is frequently switched to “independent small businesses”, perhaps better reflecting the evolving structure of the FedEx Ground model. The most highlighted new risks are the inclusion of operating leases as liabilities on the balance sheet under proposed accounting rules and the EU Emissions Trading System. The former is likely a 2016 event (if it happens) and the latter would impact all competitors.
Details
Always Tough to Declare Clean: Looking through a full 10-K and deciding there is nothing of interest is somewhat harder than finding new interesting disclosures. That said, we didn’t see anything alarming in the filing. Bloomberg picked up the disclosure of a couple of deliveries to embassies in violation of OFAC/Iran Threat Reduction Act regulations, but the ~$400 dollars in revenue is not likely to be relevant (it is our understanding that FedEx and UPS are often helpful to authorities).
Segment Outlooks: The segment outlooks read much the same as the earnings call discussion. In general, those comments seemed aimed at pushing back the expectations for timing on the profit improvement plan at Express. That seemed an odd contrast to strong FY4Q Express profitability, but managing expectations is not a bad idea for a long-term restructuring program. The language around Freight seemed slightly more positive than the earnings call (removal of "modestly" etc).
Leases Added To Balance Sheet: The risk disclosure of the potential addition of lease assets and liabilities to the balance sheet is noticeable. Although there is no date set under the current exposure draft, this is likely to be a 2016-ish event. Lease consolidation would result in significant increases in reported assets, liabilities and leverage metrics. However, nothing would change economically or operationally at FedEx – just the presentation. We also note that UPS uses short-term leases and charters, which, while economy similar (they need those aircraft), would likely not be consolidated to the same extent.
Pension/OPEB: Remeasurement of pension assumptions allowed for a very favorable change in the discount rates (as we discussed previously) in 2014. In particular, the discount rates used to estimate the benefit obligation vs. benefit cost diverged very favorably. The net aggregate pension expense change of $190 million in 2014 vs. 2013 should more than offset the postal contract headwind. The company is even lowering its expected return on plan assets to 7.75% from 8%.
Reserves and Accruals: Given the previously undisclosed ‘true-up’ that left FedEx Ground with a tough comp in FY3Q2013 vs. FY3Q2012, its noteworthy that the self-insurance accrual grew year-over-year instead of staying flat (that was an investors best clue last year). Other accruals and reserves didn’t appear noteworthy.
Kept Charges in FY13 & Purchase Price Allocation: Although not a new disclosure, reviewing the 10-K highlights that FDX took a number (~$660 million) of charges last year. While mostly just pulling expenses forward in a way that does not change the economics of a business, charges do generally help future reported profits. If it weren’t so small, we would also gripe about the purchase price allocations in the acquisitions. From the long side, prospective low quality/non-economic earnings growth always reads a little bit more favorably. But again, the numbers are very small for FDX.
More Capacity Out? As we noted with UPS, capacity in the international air market appears too high. FedEx is again highlighting that they “will be evaluating additional capacity reductions and other actions in 2014.” Capacity discipline in an oligopoly should be easy – they should all keep at it until pricing is stronger.
Independent Contractor Language Change: FedEx Ground has seen significant legal challenges to its independent contractor model over the years. In response, FedEx Ground has restructured the model so that the vast majority of ‘contractors’ would be multi-route, multi-employee ‘businesses’. The language in the 10-K was adjusted to reflect the larger size of the service providers. (See here for our expert call on independent contracting risks at FedEx)
International Domestic: The focus of recent acquisitions, as well as the highest growth segment of Express, has been the International Domestic. We continue to think TNT, which would add to this category, would make a good fit. Disclosure on the profitability of International Domestic would be very welcome, but was not included. If International Domestic revenues increase to $2 billion or so, we would expect more disclosure granularity. Currently, International Domestic is lumped in with other international businesses, leaving the trade down from International Priority to International Economy and other trends harder to evaluate.
USPS Risk Removed: We thought it was interesting, if not particularly material, that FDX removed the disclosure on the discontinuation of certain USPS services, such as Saturday delivery. The USPS was not permitted to remove Saturday delivery earlier this year, but other potential changes associated with USPS loss mitigation plans are still worth keeping an eye on. (See here for our expert call on the USPS with Dan Blair, former head of the Postal Regulatory Commission)