Amid all the talk of planes and parcels, it’s easy to forget that FedEx Corp.’s LTL business, once the company’s problem child, has become the golden child.
A business unit that accounted for about 10% of FedEx’s (NYSE: FDX) fiscal 2022 fourth-quarter revenue will never be the tail that wags the $92 billion annual revenue dog. Yet there is no denying that FedEx Freight was the star of the company’s latest quarterly show. Operating income more than doubled year-over-year to $602 million, exceeding analysts’ most optimistic estimates. Operating margin rose year-over-year by 570 basis points to 21.8%. Revenue jumped 23.3% to $2.7 billion. Daily tonnage declined 5% year-over-year in line with the general trend of lighter-weighted shipments.
Yields jumped 30% year over year and 10% sequentially, reflecting the dual tailwinds of firm pricing and fuel surcharges. FedEx Freight ended the quarter with an 78% operating ratio — the ratio of revenues to expenses — an impressive figure for any LTL carrier.
The unit’s stellar performance, which has been on display for several quarters but may have peaked in the quarter just ended, is a far cry from where FedEx Freight was a decade or so ago. During the Great Recession of 2008-09, the unit was battered by weak volumes and poor pricing, the latter the result of an ill-fated decision to drive YRC Worldwide Inc., then facing a bankruptcy filing, out of business by undercutting YRC on rates. The move backfired, and it wreaked havoc with the LTL carrier profit picture in general.
Pricing sanity was eventually restored, however. Since then, the LTL rate environment has remained firm, and no carrier has been foolish enough to offset the apple cart.
FedEx Freight clearly benefited from a bullish environment for fuel surcharges, which company executives said was the main driver of “revenue quality” for FedEx during the quarter. Other publicly traded LTL carriers will report their quarterly results over the next 45 days, and analysts expect similar fuel surcharge-related tailwinds to be reflected in their numbers. Old Dominion Freight Line Inc. (NASDAQ: ODFL), widely considered to be the best-run LTL carrier, could report an operating ratio in the 60% range due to the impact of fuel surcharge increases, according to an industry source. Old Dominion reported a first-quarter operating ratio of 72.9%.
FedEx Freight offered a preview of coming attractions because of the calendar: The parent operates on a fiscal year that ends May 31. The quarter just ended dovetailed with a near-unprecedented surge in oil and diesel fuel prices following Russia’s Feb. 24 invasion of Ukraine.
As FedEx Freight’s fortunes continued to rise, FedEx Ground, which is viewed as the key to the parent’s sustained profitability, continued to tread water. Revenue rose just 4.4%, below estimates in the high single digits. Operating income declined 4.2% to $1.05 billion, while adjusted operating margins dropped to 12.5% from 13.6% in the prior fiscal year. The unit continued to be plagued by higher costs for labor and third-party transportation, both legacies of several quarters of network disruptions blamed mostly on the shortage of labor. It also reported a $200 million increase in self-insurance costs due in part to higher claims expenses. An 11% increase in shipment yield was not enough to offset the impact of the cost increases, company executives said.
FedEx guided to fiscal 2023 earnings per share of $22.50 to $24.50 a share, higher than the original consensus of $22 per share and a year-over-year increase of 9% to 19%. Margins should expand across the three transportation segments, including FedEx Ground, where persistent cost pressures should finally be cleared, executives said, and pricing across-the-board should remain firm and come in above inflation.
Most of the broad fourth-quarter numbers came in within analysts’ expectations. Adjusted earnings per share rose 37% to $6.87 a share, revenue increased 8% to $24.3 billion and operating margin increased 50 basis points to 9.2%. The post-earnings Thursday analysts call was mostly a nonevent with FedEx and analysts preparing for a long-awaited two-day investor meeting that begins Tuesday at the company’s Memphis, Tennessee, headquarters. Executives are expected at the meeting to present a detailed blueprint for mid- to long-term profitability. The meeting comes less than a month after Raj Subramaniam, the company’s president, was named CEO to replace FedEx founder and Chairman Frederick W. Smith.
There is a sense among investors that cost and network pressures are starting to abate, said Todd Fowler, a transport analyst at KeyBanc Capital Markets. Reduced cost headwinds, combined with the company’s revenue-quality initiatives, should be favorably viewed by investors, said Fowler, who has an overweight rating and a $300 per share 12-month price target. Shares were up 7% in midday trading on Friday at $243 per share.
The company isn’t expecting much support from consumer spending, at least in the U.S.
Customer demand moderated in the fourth quarter — and has spilled over into the current quarter — as consumers felt inflationary pressures and e-commerce activity slowed as Americans returned to in-store shopping. Industrial demand, which primarily affects the fortunes of LTL carriers, has held up well as consumer activity has weakened. However, an index of manufacturing activity published Thursday by S&P Global fell to 52.4 in June from 57 in May, well below market expectations of 56 and the slowest growth in factory activity in nearly two years. The index was dragged down by contractions in output and a decline in new orders, S&P Global said.
FedEx executives expect low-single-digit volume growth in its air express and ground parcel businesses for the remainder of its 2023 fiscal year.
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