The company’s pre-pandemic moves to extend service to 7 days and add capacity for large packages at the Ground unit helped ease the strain from the surge of packages going to customers in lockdown.

(Bloomberg)—FedEx Corp. wasn’t planning for a pandemic when it began overhauling its Ground unit last year to prepare for the growth of ecommerce. But the revamp is now spurring the courier’s biggest share gains since 1998.

Before COVID-19 began to spread across the globe, the company had already moved to 7-day service, expanded capacity for larger packages, introduced a new routing software and began pushing more Express packages into the lower-cost Ground network. Those changes helped it increase profit on a flood of residential packages while its more lucrative business deliveries shriveled up amid a U.S. lockdown.

Driven by a 20% surge in revenue at the Ground unit and margins that held up better than expected, FedEx’s profit per share for the quarter ending in May smashed analysts’ diminished expectations by $1 a share, sending the stock soaring to its highest price in four months.

Home deliveries accounted for 72% of the division’s sales by volume, compared with 56% in the same period a year earlier.

“Ground margin performance was much better than feared,” said Allison Landry, an analyst with Credit Suisse. “This relative stabilization will go a long way toward restoring investor confidence that FDX has a handle on reining in what the market had deemed to be out-of-control cost inflation.”

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Enduring changes

FedEx jumped 16% to $162.55 at 10:02 a.m. in New York after advancing as much as 17% for the biggest intraday gain since December 1998.

The performance put FedEx in a good position to take advantage of heavy ecommerce demand sparked by people staying home to protect against the virus, and those changes are expected to endure. The company is also raising prices, implementing surcharges in June on large customers with virus-related volume surges. It plans to apply peak seasonal charges as well for peak holiday demand.

“I anticipate customers to pay more for pricing in November and December moving forward, and I do think that that will be a structural shift in the market,” said Brie Carere, FedEx chief marketing officer on a conference call with analysts.

The courier said it held costs in check with a mix of job cuts, reduced incentive compensation, aircraft retirements and delays to some investment projects. Those actions and a drop in fuel costs helped offset $125 million needed to protect workers from the COVID-19 pandemic, FedEx said in a statement Tuesday as it reported earnings for the three months ending May 31.

FedEx’s better-than-expected results underscore the company’s efforts to shore up its profit margins amid pressure from soaring residential deliveries, which are typically less profitable than commercial shipments. The company’s pre-pandemic moves to extend service to 7 days and add capacity for large packages at the Ground unit helped ease the strain from the surge of packages going to customers in lockdown.

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Accelerated strategy

“The trends we experienced during the quarter validated, or rather, put an exclamation point on the importance of our strategic initiatives that directly address ecommerce,” FedEx chief operating officer Raj Subramaniam said on a conference call with analysts. “In many ways, the macro trends accelerated to meet our existing strategy and what we expected to happen over a few years happened in a matter of a few months.”

While FedEx’s adjusted earnings dropped by about half to $2.53 a share for the fiscal fourth quarter, the performance surpassed Wall Street’s expectations. Analysts had predicted $1.53, according to the average of estimates compiled by Bloomberg. Sales slipped 2.2% to $17.4 billion.

Uncertainty ahead

Looking ahead, FedEx said it has seen week-over-week improvement for business packages since the end of April. But the company said there was too much uncertainty to provide financial forecasts for fiscal 2021.

To conserve cash, FedEx is slashing capital expenditures by $1 billion to $4.9 billion in the coming year and doesn’t plan to contribute to its U.S. pension plan. In each of the last two years, it contributed $1 billion to the plan.

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The company’s Express air-cargo unit picked up volume as the government and corporate customers air-lifted personal protective equipment and other essential goods to combat the worldwide pandemic. Some cargo that otherwise would have been transported by passenger planes was shifted to freight couriers when air travel crumbled. It will take a least 18 months for that airline freight capacity to return, FedEx said.

That helped make up for a decline from businesses that were closed to stem the virus from spreading. Still, the Express unit’s sales fell almost 10% to $8.6 billion and margins dropped by more than half to 3.9%.

Residential rush

Sales at FedEx’s Ground unit leaped by 20% to $6.4 billion from a year ago, driven by consumers ordering items online instead of venturing out to stores. Margin were about 11% compared with 15% a year earlier. Home deliveries tend to include a limited number of packages per stop, making them less profitable than shipments to businesses.

Still, the Ground operation’s margins and volumes were stronger than expected, said Bloomberg Intelligence analyst Lee Klaskow. The unit also will benefit as the economy reopens.

“FedEx provided reason for optimism,” Klaskow said in a note.

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For the company as a whole, the adjusted operating margin of 5.2% surpassed the 3.4% level predicted by analysts.

Profitability should get a boost from surcharges that FedEx applied beginning in June to the pandemic-fueled surge in parcels from the company’s largest ecommerce customers. FedEx said it also plans to apply surcharges for the peak November and December shipping season.

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