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Morningstar | Express and Ground Margins Falter, FedEx Further Reduces Guidance; Shares Still Cheap

FedEx reduced fiscal 2019 guidance in a second consecutive quarter due to sluggish macroeconomic conditions in Europe and China as well as weak global trade growth. The firm now expects in the year ending in May to generate EPS of $15.10-$15.90 versus the quarter-ago $15.50-$16.60, excluding TNT integration, a Ground legal matter, a deferred tax remeasurement, and business realignment efforts including U.S. voluntary employee buyouts. We are updating near-term factors in our model--slightly lower demand for Express, slower yield increases, and near-term parcel margins a bit lower than our previous projections--and expect to move our fair value estimate moderately downward.

Express and Ground generated stilted margins due to mix rich in e-commerce and the costs of improving TNT. The B2C challenge of delivering few parcels per destination is known, but the quarter showed other challenges with packages lightening and shipping distances shrinking due to fulfillment from regional distribution centers. Revenue per piece declined 2% in Express U.S. packages, negative 5% in international export, and negative 2% in international domestic. Ground revenue per piece increased a modest 2.7%--about half the level of the prior two quarters.

During the quarter reported consolidated operating margin improved 16 basis points to a disappointing 5.4%. Express improved to 4.1% and Freight improved 250 basis points to a modest 5.5%, but Ground contracted 175 basis points to 11%. Express and Freight were about half the margin level the firm targets for these segments and below our expectations.

FedEx plans to complete renewal of its jets by 2023. It continues to integrate and improve TNT operations and expects related fiscal 2019 expenses to be $435 million. Ground rolled out six-day operating weeks this year, and we think that will eventually bear fruit. FedEx continues to target small-medium businesses and is in the midst of a voluntary employee buyout to rightsize U.S. Express.

Parcel demand was up 2% in Express but within this, declined 1% in U.S. overnight and grew a fast 19% in cheaper U.S. deferred parcels. Ground package volume improved 6%--in line with recent quarters. FedEx Revenue improved 3% year over year, but Express revenue declined 1% year over year. Ground and Freight improved their top lines 8%-9%.

Looking forward, management claimed to see green shoots in some regions and proposed no reduction to its capital expenditures budget, which it maintains is best for the long term.