Earnings Preview: FedEx

FedEx Corporation (FDX), the world’s second-largest package delivery company, is slated to release its fourth quarter 2011 earnings on June 22, before market opens. The current Zacks Consensus Estimate for the fourth quarter is $1.72, representing a substantial 29.35% annual growth.

FedEx saw negative surprises of 0.83%, 11.45% and 1.22% in the last three quarters (first, second and third quarters, respectively). Earnings growth in the fourth quarter will likely be restricted by several cost headwinds such as higher compensation and benefits, including retirement plans and medical costs, and continued higher aircraft maintenance. However, these costs headwinds are expected to be countered by continued growth in volumes and stronger yields.

At its third quarter conference call, FedEx projected adjusted earnings in the range of $1.66 to $1.83 per share for the fourth quarter. The company also expects its fiscal 2011 earnings in the range of $4.83 to $5.00 per share.

Including FedEx Freight combination costs and the legal reserve, management guided fiscal 2011 earnings between $4.49 and $4.66 per share.

Third Quarter Flashback

In the third quarter, FedEx’s adjusted earnings missed the Zacks Consensus Estimate by a penny but was a nickel above the year-ago earnings. Lower shipping volume and increased costs were responsible for the underperformance. Additionally, unusually severe winter storms during the quarter disrupted the company’s operations.

Total revenue improved from the year-ago quarter and surpassed the Zacks Consensus Estimate driven by healthy demand and strong yield initiatives. Strong exports from Asia and Europe drove revenues in the FedEx Express segment.

Package volume growth as well as FedEx SmartPost spurred FedEx Ground revenues. Though partially offset by lower shipments, FedEx Freight revenue increased reflecting higher average daily less-than-truckload (LTL) yields.

Operating expenses increased 12% mainly on high fuel costs. Other expenses such as resumption of certain 401(k) employee compensation programs, higher pension and medical costs, increased aircraft maintenance expenses, merit salary increases as well as costs associated with the combination of FedEx Freight and FedEx National LTL operations, effective January 2011, also added to the higher expense.

Agreement of Analysts

Estimates for the fourth quarter have been trending downward over the last 30 days. Out of 25 analysts, 3 have made downward revisions while none moved in the opposite direction. Over the last 7 days, only one analyst revised the estimate upward while none made any downward revision.

For fiscal 2011, out of 25 analysts, 3 revised their estimates downward over the last 30 days. Only one analyst made a positive revision to the estimate over the last 30 days.

The analysts have turned cautious due to surging fuel prices, the ongoing political turmoil in the Middle East and North Africa and uncertainty regarding the near-term impact of the earthquake and tsunami in Japan on the company’s operational costs, shipping patterns and the global economy. Further, the analysts expect higher compensation and benefit expenses and increased aircraft maintenance costs to restrict earnings in the fourth quarter.

The analysts with positive revisions believe that FedEx is taking full advantage of the global economic recovery by investing strategically in key international growth markets, purchasing more efficient aircraft (Boeing 777 freighters) and streamlining its network.

The company has also undertaken several initiatives, such as continued yield improvement as well as strong pricing, which are expected to fuel earnings growth over the next several years. In addition, the integration of the Freight segment will help it to return to profitability in the upcoming quarter.

Further, FedEx’ long-term goals of 10.0% revenue growth per year, more than 10.0% operating margin, earnings per share in the range of 10.0–15.0% per year, improving cash flows, and increasing returns on invested capital affirm the analysts’ confidence on the stock.

Magnitude — Consensus Estimate Trend

The magnitude of revisions for the fourth quarter has been static at $1.72 per share over the last 7 days. The Zacks Consensus Estimate reduced from $1.73 expected 30 days ago. However, fourth quarter expectation is within the management’s guidance.

For fiscal 2011, the Zacks Consensus Estimate is $4.90, unchanged in the last 7 days but a penny below the last 30 days. The Zacks Consensus Estimate for 2011 is within management’s guidance and reflects a significant 30.35% gain year over year.

Our Analysis

We believe improvements in production growth, pricing and volumes as well as strong yield across all revenue segments will facilitate FedEx to generate strong revenue and earnings growth. Further, the restructuring of the Freight segment, which is operating at a loss, will bring its profitability back.

Following stiff competition from its close rival United Parcel Service Inc. (UPS), FedEx is boosting its international business through the enhancement of existing routes as well as strategic acquisitions. Going forward, robust economic growth in Asia, Latin America, China, India, Mexico and Brazil will continue to remain a source of growth.

Further, FedEx is committed to its shareholders in the form of dividends. However, rising fuel prices risks related to the disaster in Japan as well as cost headwinds will limit the upside potential of the stock.

Consequently, we are maintaining a long-term Neutral rating on FedEx. The stock also retains a Zacks #3 Rank (Hold) for the short term.

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