The narrow-moat company showed progress on TNT integration and restoring Ground margins, but we're skeptical on the value of the Freight segment.
handled record peak season volume with aplomb and affirmed its 2017 earnings guidance despite challenges in the quarter, such as providing requested capacity to clients who failed to consume it, and fuel costs soaring 30% over the prior-year period. We expect to increase our fair value estimate modestly due to the firm’s pushing $300 million of Ground capital expenditure into next year, and we maintain our narrow moat rating.
Keith Schoonmaker, CFA, is director of industrials equity research for Morningstar.
We were keen to see progress on TNT integration and restoration of Ground margins. Express grew revenue 3% to $6.8 billion with an 8.6% operating margin, whereas TNT generated $1.8 billion of sales and an adjusted 2.2% EBIT margin. We believe margins on the TNT business will double by 2021, and we're already refining our TNT expectations upward from our current projections of making losses during this and next year. Key integration areas are optimizing pickup and delivery areas, operating one integrated global express network, improving staff productivity using technology, and growing revenue through a single sales team and single client Internet view. Management is confident and pleased with progress at TNT.
Ground grew its top line 6% and the segment’s 11% EBIT margin was still hampered by staffing up for network expansion, fuel cost, and one fewer operating day than in the prior-year period. However, management expects Ground will produce at least 15% margin in the fourth quarter, and this team is typically pretty conservative when it gives guidance.
We’re still skeptical on the value of the Freight segment. Only an airline considers trucking asset light, and this segment produces low margins. Management maintains its longstanding (long suffering?) 10% margin target for Freight, yet for the period was only 2.7%. This was a modest decline from 3.9% in the prior-year period, and still a drag on the 8.6% consolidated mean margin. We consider the LTL trucking industry devoid of moats, and FedEx is the largest LTL trucker in the U.S.
Morningstar Premium Members gain exclusive access to our full analyst reports, including fair value estimates, bull and bear breakdowns, and risk analyses. Not a Premium Member? Get this and other reports immediately when you try Morningstar Premium free for 14 days.