Summary
FedEx may have missed consensus for the quarter, but from what we can see, it was mostly due to the impact of the late Thanksgiving holiday on FedEx Ground’s margin. Estimating the impact of the early Thanksgiving holiday was particularly difficult going in, as we had noted (Metrics Changing?). The slight raise in guidance suggests that management expects holiday volume to merely shift to FY 3Q. The Express margin showed good headline gains and is the real focus for many investors. We will wait for the detail and disclosure in the 10-Q (likely tomorrow afternoon) for a fuller analysis.
A Few Highlights
Express Margin: The Express segment margin showed solid (+1.4 percentage points YoY) improvement, driven presumably by fuel, headcount reductions and lower overhead costs. FedEx Express also showed a 16 basis point improvement in its ex-fuel Margin YoY, despite the new USPS contract, holiday shift and other potential headwinds. In our view, it’s the Express segment margin expansion that counts and it reasonably promising in the release.
Intercompany Cost Reallocation: The reallocation of intercompany expenses remains a driver of the YoY improvement of the Express margin. Last quarter, overhead declined YoY, which was not the case this quarter. That raises some questions around cost reshuffling vs. cost reductions, but the effect does not appear large enough to be a game changer.
Trade Down Easing?: This quote from the press release was interesting to us: “Within the IP category, average daily volume for the lower-yielding distribution services declined while IP average daily volume, excluding these distribution services, increased 1%. FedEx International Economy® average daily volume grew 10%.” The phrase "trade down" was not even in a conference call question, at least that we heard.
Guidance Change: The guidance move was small, but in the right direction. There was no particular reason to look for a large guidance change in this quarter. The bump appeared geared toward reassuring investors about the FedEx Ground holiday timing issue.
Sticking With What Is Working
We have 'liked' FDX shares since our November 2012 Black Book ("When Will Then Be Now? Soon"), presenting FDX (and Deutsche Post) as a top long idea. Our thesis centered on the potential for the Express division to be made significantly more profitable. At the time, FedEx Express was 'free' in our valuation, presenting an attractive risk/reward. After a near 60% rally in FDX shares since then, we still think FedEx Express has some additional value to be recognized by the market. Importantly, we now have some evidence that they are making progress - albeit slow. We will also wait for better detail in the 10-Q tomorrow, as we were surprised by some of the incremental disclosures last quarter.
