FedEx Corporation continues to improve margins, financial performance and competitive position, chairman Fred Smith told an analysts' conference call yesterday following the publication of the company's third quarter results.
However, he noted "three recurring areas of concern – expressed in various articles and reports" – industry disruption – in particular, the threat posed by Amazon, future margins and capital spending.
Smith said concerns about industry disruption "continue to be fuelled by 'fantastical' – and let me emphasize I chose this word carefully – articles and reports which are devoid of in-depth knowledge of logistic systems and the markets which FedEx serves."
As the company had previously noted, network design technology, facilities capabilities and route/stop density are the key elements in the FedEx, UPS and (US) Postal Service systems and it was highly likely that these entities will remain the primary carriers for e-commerce shipments in the US for the foreseeable future, he underlined.
Regarding margins, Smith revealed that the Express segment's profit improvement program will be exceeded by May 31. "Express segment margins in the current fourth fiscal quarter will be approximately 12%," compared to 9.1% in Q3, which was up from 5.9% the previous year.
As for capital spending, Smith said the company was "currently investing in FedEx Express fleet modernization and expansion of FedEx Ground’s highly automated facilities."
He emphasised that both of these major programs had high returns and were integral to margin expansion. "Our cash flows are such that we can easily fund investments at US$4 billion to $5 billion per year while retiring debt used to acquire TNT if the transaction is approved and stock repurchases. Of course we include replacement capex in this projection.
"To reiterate, we believe FedEx will continue to improve margins, EPS, capital returns and increase cash flows which we have told you repeatedly over the last couple of years and again have demonstrated this quarter."
The highlights of the three months to end-February 2016 included a 19% increase in adjusted operating income year over year to $1.16 billion, "primarily due to improved yield management and the continued positive impacts from profit improvement program initiatives at FedEx Express." Q3 revenue totalled $12.7 billion, up from $11.7 billion a year earlier.
Commenting on the outlook for the full fiscal year ending May 31, FedEx Corp. executive vice president and chief financial officer, Alan B. Graf, Jr., told the conference call: “We now expect our fiscal 2016 adjusted earnings to be up 20% to 22% over last year, as we continue to benefit from our execution of the profit improvement program. Our positive financial momentum should continue into our upcoming fiscal 2017, where we expect solid growth in earnings and cash flow.”
Looking at the Q3 performance by segment, the stand-out figure in FedEx Express' results was the operating income, up 51% from million a year ago at $595 million on revenue down 1% at $6.56 billion.
Graf underlined that the 'star' Express segment had turned in an "outstanding" quarter. "Operating income climbed 51% and operating margin increased despite lower revenues. Who does that? Express operating margin was 9.1%, a 320 basis points versus last year and is the best third quarter margin in Express segment history."
He explained that the increase was driven primarily by yield management, US domestic volume growth, and ongoing benefits from the profit improvement program.
"Express is efficiently managing volume increases in e-commerce and at the same time continued softness in international volumes. The profit improvement program that we announced in 2012 continues to improve revenue quality, increase productivity, and constrain expenses."
As for the FedEx Ground segment, operating income was flat at $557 million but revenue was up 30% at $4.41 billion.
Revenue increased due to an 11% increase in FedEx Ground volume, improved yield management, the recording of FedEx SmartPost revenues on a gross basis versus the previous net treatment and the inclusion of GENCO results for the entire quarter versus one month in the prior year’s results.
In the FedEx Freight segment, operating income was down 16% at $56 million on revenue up 1% at $1.45 billion. Less-than-truckload (LTL) average daily shipments increased 7%, mostly offset by lower fuel surcharges and weight per shipment. Operating results declined primarily due to salaries and employee benefits expense outpacing volume growth.
Also present at the call was FedEx Services' president and CEO, Mike Glenn, who commented on the "industry dynamics" that had enabled FedEx to achieve a record peak season in 2015 with more than 325 million packages delivered during the period.
"The 2015 peak season was historic by many measures and it was driven by the continued growth of e-commerce."
He said demand for residential deliveries across the industry surpassed expectations as consumers increased online shopping in record numbers, not only with their higher volumes but the types of goods purchased online increased.
"FedEx experienced record demand including multiple days of greater than 25 million packages delivered which is more than double our average daily volume." He said it had become very clear that e-commerce had now enabled "the full scale of retail revolution."
Turning to the speculation about how far Amazon is planning to go in developing its own transportation capabilities, Glenn played down the likelihood of Amazon emerging as a serious competitor to integrators in the US claiming it would demand a huge financial outlay on the internet retailer's part and take too long to build-up a comparable network.
"First, Amazon is a valuable customer that we've worked with for many years and we expect to work with them for many years to come. We’ve been in constant dialogue with them to understand their transportation needs as they've experienced significant growth. We’ve been aware of Amazon’s need for supplemental capacity related to inventory management, which is driving some of the investments they are making in transportation."
He explained that large retailers have long had their own transportation capabilities, primarily to enable movement and positioning of inventory across their store and fulfillment locations.
"While recent stories and reports of a new entity competing with the three major carriers in the United States grabs headlines, the reality is it will be a daunting task requiring tens of billions of dollars in capital and years to build sufficient scale and density to replicate existing networks like FedEx."
Glenn said it was also important to note that no one FedEx customer represents more than approximately 3% of total revenue. "Additionally, other than the Postal Service, no single customer represents more than approximately 3% of revenue for FedEx Express, FedEx Ground, or FedEx Freight. We manage these relationships carefully to ensure we don't become overly dependent on any one customer."
Glenn went on to underline that FedEx will continue to be "a key enabler for e-commerce" in the years ahead.
"By our estimates, more than 95% of all e-commerce orders today are delivered by one of three entities in the United States: FedEx, the United States Postal Service, with whom we have a strategic relationship to transport the priority mail and UPS. In fact, if we were to isolate our e-commerce business one could argue that FedEx is one of the most profitable e-commerce companies in business today."
