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FedEx Corporation (FDX - Analyst Report) reported second quarter fiscal 2013 adjusted earnings of $1.39 per share. The results missed the Zacks Consensus Estimate of $1.41 and decreased from the year-ago earnings of $1.57. Results were affected by Superstorm Sandy, which hit the quarter’s earnings by 11 cents per share.

Total revenue for the second quarter climbed 5% year over year to $11.1 billion, surpassing the Zacks Consensus Estimate of $10.8 billion.

Operating income was down 8% year over year at $718 million. Operating margin deteriorated 90 basis points (bps) to 6.5% from 7.4% in the year-ago quarter.

Segment Results

Quarterly revenues at FedEx Express were $6.86 billion, up 4% year over year. The growth was driven by acquisitions and growth in FedEx Trade Networks, offset by economic volatilities and superstorm Sandy.

Operating income was down 33% year over year at $230 million, resulting in an operating margin of 3.4%, down 180 bps from 5.2% in the year-ago quarter. The negative impact of lower volumes due to demand shift toward international services with lower profitability continue to affect the segment’s operating income. In addition, fuel price adjustments, higher depreciation and pension expenses also contributed to the decline.

The FedEx International Priority (IP) average daily package volume increased 3.2% for the quarter, while revenue per package (yield) decreased 4.9% due to the unfavorable impact of exchange rate fluctuations and lower fuel surcharges. The U.S. domestic revenue per package rose 1.4% year over year despite a 2.1% decline in the U.S. domestic average daily package volume. The revenue growth was primarily attributable to higher freight rates that offset lower fuel surcharges.

FedEx Ground revenue increased 11% year over year to $2.59 billion attributable to volume growth. Operating income grew 4% year over year to $412 million, resulting in operating margin of 15.9%, down 110 bps year over year. The growth in operating income was backed by higher shipments and yields, offset by higher contractor rates, expansion costs and Sandy storm. Whereas, operating margin declined due to lower fuel surcharge and higher purchased transportation expenses.

FedEx Ground average daily package volume increased 8% driven by growth in B2B and FedEx Home Delivery services. Revenue per package grew 2% on increased freight rates and extra service revenues. FedEx SmartPost average daily volume expanded 17% on increased e-commerce and net revenue per package increased 2% due to rate increases, offset by higher postal rates.

FedEx Freight revenue increased 4% year over year to $1.38 billion, reflecting growth of 2% each in LTL (less-than-truckload) yield and average daily LTL shipments. FedEx Freight recorded an operating income of $76 million that shot up 90% from $40 million in the year-ago quarter. The whopping growth was powered by higher yield, volume and operational efficiencies. Operating margin improved to 5.5%, up 250 bps year over year.

FedEx Services revenue fell 5.2% year over year to $405 million in the second quarter.

Liquidity

FedEx exited the second quarter with cash and cash equivalents of $2.5 billion compared with $2.8 billion at the end of fiscal 2012. Long-term debt stood at $2.2 billion compared with $1.3 billion at the end of fiscal 2012. Capital expenditure for the second quarter amounted to $1.8 billion compared to $4 billion at fiscal year-end 2012.

Guidance

For the third quarter of fiscal 2013, FedEx has projected earnings per share in the range of $1.25 to $1.45. For fiscal 2013, the company reiterated its earnings per share projection in the range of $6.20 to $6.60. The company maintains its capital expenditure estimate of approximately $3.9 billion for fiscal 2013.

In addition, the company expects to incur expenses under its voluntary buyout program. The company expects pre-tax expenses under this voluntary buyout program to range from approximately $550 million to $650 million, or $1.09 to $1.29 per diluted share.

Our Analysis

Apart from the sluggish economy that has brought down market demand, factors like global sales mix shift from priority to deferred shipments also remain detrimental. Further, demand shift from Express to Ground deliveries to reduce shipping cost also contribute adversely to the company’s Express segment.

As a result, we are cautious about Express margin improvement and do not foresee much of upside until demand improves in the segment’s international business and costs improve in its domestic operations. In addition, increased investment, competitive threat from peers like United Parcel Service, Inc. (UPS - Analyst Report) and unionized workforce and rising pension headwinds could limit the upside potential of the stock.

FedExretains a Zacks #4 Rank, implying a short-term (1-3 months) Sell rating. For the long term, we have an Underperform recommendation on the stock.

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