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Will High Costs at Ground Unit Mar FedEx's (FDX) Q1 Earnings?

Zacks Equity Research

FedEx Corporation’s FDX Ground unit, which accounts for more than 28% of the company’s total revenues and around 59% of its operating income, is expected to be hurt by high costs when it reports first-quarter fiscal 2020 results (ended Aug 31, 2019).

This, in turn, might drag down FedEx’s overall quarterly earnings and make it difficult for the company to outperform on the bottom-line front. Notably, FedEx is scheduled to post first-quarter fiscal 2020 results on Sep 17. (See more in FedEx to Report Q1 Earnings: What's in the Offing?)

FedEx Ground offers low-cost, day-certain service to any business address in the United States and Canada as well as residential delivery in the United States through its FedEx Home Delivery service. 

FedEx Ground’s Q4 Performance

Revenues at FedEx Ground increased 11% year over year to $5.32 billion driven by upbeat e-commerce volume. Operating income came in at $810 million, nearly flat year over year. Meanwhile, operating margin contracted to 15.2% from 16.9% in the prior-year quarter.

Operating results at this low-cost delivery segment were hurt by higher purchase transportation rates in addition to the year-round six-day per week operations launched in January.

High Costs Likely to Hurt FedEx Ground in Q1

In the first quarter of fiscal 2020, the Ground segment’s results are likely to be hurt by high expenses due to its steady investment in enhancing capacity, technology and automation. Notably, this particular unit is FedEx’s second-largest revenue-generating unit after the Express division.

At the segment, operating costs are likely to move north in the to-be-reported quarter due to factors like the expansion of FedEx Ground’s delivery schedule, improvements pertaining to capabilities for large packages apart from investments directed toward enhancing efficiencies and safety.  Moreover, the company is incurring costs as it aims to integrate FedEx SmartPost package volume into the stand operations of the Ground segment.

As in the past few quarters, solid e-commerce growth is likely to boost first-quarter revenues at the Ground segment. In fact, FedEx Ground will deliver packages seven days a week from January 2020 in a bid to serve the rapidly growing e-commerce market.

Furthermore, investors will look forward to updates on FedEx’s decision pertaining to non renewal of its ground delivery contract with e-commerce giant Amazon AMZN. Since the duration of the contract was till Aug 31, 2019, the above decision will not impact the first-quarter fiscal 2020 results.

Backed by upbeat e-commerce growth, the Zacks Consensus Estimate for first-quarter revenues at the FedEx Ground unit stands at $5,133 million. In the year-ago quarter, the segment recorded revenues of $4,799 million. However, the same for segmental operating income is pegged at $672 million, indicating a sequential decline due to high costs.

Overall Earnings & Revenue Projections

For FedEx, which competes with United Parcel Service UPS in the package delivery space, the Zacks Consensus Estimate for first-quarter earnings is pegged at $3.20. This indicates a 7.5% decline from the prior-year quarter’s $3.46 per share. For quarterly sales, the consensus mark of $17.14 billion suggests a marginal increase on a year-over-year basis.

Our Take

While surging e-commerce volumes are likely to boost revenues at FedEx Ground, high costs might hurt segmental operating margin in the quarter to be reported. The margin compression at this key segment, in turn, might weigh on this Zacks Rank #3 (Hold) company’s overall results. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Key Pick

Investors interested in the Zacks Transportation sector may consider GATX Corporation GATX, carrying a Zacks Rank #2 (Buy). GATX has an impressive estimated EPS growth rate (three to five years) of 15%.

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