Editor's Note: This research note was originally published March 19, 2014 by Hedgeye’s Industrials Sector Head Jay Van Sciver. For more information on Hedgeye please click here.
Summary
Excluding the impact of weather, FedEx (FDX) reported a solid quarter on several key metrics. This was the toughest winter in which FDX has “ever” operated, according to CEO Fred Smith, who probably knows.
But are the profit improvement plan benefits accelerating?
There are a number of adjustments that are needed to make the year-over-year comparison and it would be a mistake to read too much into a single troubled quarter, but FY3Q 14 looks pretty good for a challenged quarter (Express margin up about 50-70 bps on our adjustments). Not exactly acceleration, but this was not the quarter to expect it.
As usual, we will want to see the 10-Q, particularly on what looks like weaker cash generation. On balance, the report looks relatively uninteresting (nothing wrong with that) and we do not see anything so far that meaningfully impacts our longer-term thesis.
Key Points
FedEx Express Margins: To make a decent year-over-year comparison on the operations at FedEx Express, one needs to make a number of adjustments. One extra operating day, with one-third to one-half of costs not varying, is a year-on-year benefit. Weather was a $70 million headwind, according to management.
We estimate that fuel surcharge timing was a slight headwind year-over-year (while a significant absolute negative in both periods) and the postal service contract was also a negative YoY, partly offset by lower pension. Business realignment charges impacted both periods, but were larger in the year ago quarter. Adjusting for those items, we get a rough 50-70 basis point improvement. That seems good enough to maintain expectations for the eventual success of the profit improvement program. Of course, the profit improvement plan goal is to deliver closer to ~5x that gain by FY16, with that progress coming more slowly.
FedEx Ground: Excluding the estimated impact of weather, FedEx Ground showed a solid margin of ~17.1%, in line with guidance. Some may have expected the late Thanksgiving holiday to push a greater improvement in FY2Q 14, but the result is probably good enough even with the Ground operating day add in. Next year, a late Thanksgiving will also compress the e-commerce shopping season and we expect both FDX and UPS will be better prepared for high peak volumes.
Outlook and Buyback: When asked about 2015 estimates, management highlighted the share repurchase program. The repurchase does get FDX a good part of the way to meeting consensus, when combined with the current profit improvement plan momentum. We should receive better insight into 2015 with the June release.
Upshot
Given the unusual operating environment and adjustments, it is hard to extrapolate FY3Q 14 results too far. That said, it looks okay and we do not expect a particularly interesting reaction to the report. FedEx Express remains reasonably on track with respect to its profit goals in a challenging operating environment.
