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FedEx Short on Holiday Cheer

Solid package volume aside, the company's forecast irks investors.
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Updated from 11:37 a.m. EST



shares stumbled Wednesday after the company's profit forecast for the second half of the year left more room for a shortfall than investors were willing to accept.

Earnings are expected to be $1.20 to $1.35 a share for the third quarter, well below the average estimate of $1.55 carried by Thomson Financial. However, fourth-quarter earnings are likely to be $1.98 to $2.13, compared with the average estimate of $1.98.

As a result, FedEx is anticipating full-year profits of $6.35 to $6.65 a share. Excluding the net impact of costs associated with its pilots' contract, earnings should be $6.60 to $6.90. If FedEx comes in toward the low end of that range, it would miss the consensus Wall Street target of $6.82.

During a conference call, CFO Alan Graf disputed the suggestion that the results were disappointing. "We have the same outlook for the year that we had last quarter," he said. "We are going to have a strong year. We are very excited about the momentum we are developing."

Analyst Helane Becker of Benchmark Capital called FedEx "a good company in a great industry" and said a decline in the share price should be viewed as a buying opportunity. She said investors may have misunderstood the impact of the company's fuel surcharges, which helped the second quarter results but will negatively impact the third quarter.

Additionally, Becker said, there may have been a misinterpretation of conference call remarks by CEO Fred Smith, who mentioned the slowdown in housing and manufacturing. "The two events combined, produced a selloff," she said.

Shares of FedEx closed the session down 1.9% at $111.85 on three times its normal volume.

Concerns about the outlook more than offset a solid second quarter from FedEx. Net income in the latest quarter rose 8% from a year ago to $511 million, fueled by a strong increase in package volume.

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The company earned $1.64 a share, while revenue rose 10% to $8.93 billion for the second fiscal quarter, which ended Nov. 30.

FedEx said earnings would have been $1.89 a share but were reduced by 25 cents by costs associated with the new pilots' contract. Analysts were looking for a profit of $1.76 on revenue of $8.91 billion.

Graf said second-quarter results benefited from the six-week lag between the time that the company sets its fuel surcharge and the time when the charge took effect, as fuel prices fell. "Conversely, the third quarter will be negatively impacted by the same timing issue, most notably at Express," he said. Full-year results won't be affected, he said.

During the second quarter, ground package volume rose 14%. Combined average daily package volume at FedEx Express and FedEx Ground grew 7%. Operating income was $839 million, up 6%. Operating margin was 9.4%, down from 9.8% in the same quarter a year earlier.

By segment, FedEx Express revenue rose 6% to $5.6 billion, while operating income advanced 5% to $502 million. FedEx Ground had revenue of $1.52 billion, up 16%, and income rose 17%. But other divisions showed declines.

At FedEx Freight, revenue rose to $1.23 billion, up 31%, but the margin fell to 11.3%, down from 14.4%. The company said the decline reflects the effort to integrate the acquisition Watkins Motor Lines, which is being rebranded as FedEx National. Additionally, the trucking business has shown drop-offs nationally.

Meanwhile, FedEx Kinko's' reported revenue of $519 million, down 2%. Operating income fell 50% to $8 million, and margins were halved to 1.5% from 3%. The declines were due to reduced demand for copies, network expansion costs and a sales force reorganization.

Smith said FedEx Kinko's will be around break-even for the next two or three years, but that "the amount of traffic we are generating benefits both Express and Ground significantly. It gets only a transaction fee, but for the corporation as a whole, it's very beneficial."

Profit expectations aside, executives forecast positive growth at FedEx despite a slowing economy. The second half will be "not quite as strong as we saw the first half of our fiscal year, but we believe we will be able to produce solid results going forward," said Mike Glenn, executive vice president.

Added Smith: "We see steady performance by a healthy global economy, led by continued strong growth in Asia

with somewhat slower growth in the U.S."