FedEx Express users of slower services will bear more of the brunt of the parcel carrier's price hike than shippers that use faster options, as the company works to slow shippers from shifting to cheaper delivery options, according to Stifel Nicolaus research note.
The parcel giant's “accessorial and other charges will mean that the actual effect of the customary 5.9 percent rate increase (3.9 percent net of a 2 percent fuel surcharge reduction) will be greater among lower-cost products and smaller among higher-cost products in order to dampen trade down effect,” according to the Sept. 19 research note from the investment research firm. The imbalance reflects FedEx’s growing challenge to realign its networks for more cost-cutting shippers.
The Memphis, Tenn.-based company plans to explain how it will make “significant” cost cuts to its express unit at an investors’ meeting from Oct. 9-10, FedEx CEO, Chairman and President Fred Smith told investors on Sept. 18, according to a SeekingAlpha transcript.
“But we're not going to lay off people and we're not going to take some draconian steps,” he said. “All of the things are very well-thought-out, and we're very confident we can achieve them, and I think you'll be surprised at the magnitude.”
Although FedEx Express revenue ticked up 1 percent year-over-year in the first fiscal quarter, the unit’s operating margin shrank to 3.3 percent from 4.4 percent. FedEx said the growth in deferred services “outpaced our near-term ability to reduce” the operating cost of the express business.
Along with the broader push to cut transportation costs, higher jet fuel prices and more belly capacity in long-range passenger aircraft have spurred shippers to shift products to lower-cost, deferred services. Smaller gadgets have also lessened air express volume, and “the product launch of Apple’s and Microsoft is not going to provide the type of sustained growth in the international trade that the world has seen historically,” Smith said.
More reliable container shipping and the greater economies of scale delivered by larger vessels have also spurred customers to ship more via ocean than aircraft. Better inventory management allows shippers to tap ocean shipping, which is on average one-tenth the price of air delivery.
“The air cargo market in its traditional definition is not growing. The door-to-door express portion of it is growing relative to the overall market, and the —a lot of traffic is moving onto the water because moving goods by air is very energy-intensive,” Smith said.
This shift is further exacerbatd by a sluggish global economy. FedEx lowered its fiscal year earnings forecast by up to 6 percent on Tuesday, saying it believed the U.S. and broader global economic growth wouldn't be as healthy as expected. Paralleling the expectations of many economists, FedEx expects global GDP to hit 2.3 percent in 2012 and 2.7 percent for 2013, a 0.3 percentage point trim from the carriers’ last forecast. U.S. GDP will expand at 2.2 percent this year and 1.9 percent in 2013, according to FedEx.
“Global trade has grown faster than GDP, except for the 2000, 2001 meltdown and 2008 and 2009, for 25 years. And over the last few months, that has not been the case,” Smith said.
Shippers’ trading down for more economic services can also been seen in FedEx Freight business. The less-than-truckload operator’s yield increased at a slower rate than the last two quarter, suggesting more loads are being handled by the division’s lower-price economy service rather than its priority service. The unit’s profit soared 114 percent year-over-year to $90 million in the first quarter on a 5 percent revenue increase.
The carrier is also harnessing shippers’ shift to ocean shipping by expanding its forwarding and customs broker arm, FedEx Trade Networks. FedEx has dramatically expanded the unit’s presence in the last three years to 130 offices in 25 countries, with the most recent addition in Glasgow, Scotland.
FedEx will “continue to build scale at FTN, and we’re going to continue the expansion. But there is not a customer out there right now that FTN can’t compete for, which a position we haven’t been in until just recently,” said Alan Graf, chief financial officer and executive vice president.
The shift in shippers’ service preference isn’t happening in a vacuum, and FedEx’s dampened fiscal first quarter earnings and global outlook could forewarn of a similar scenario at its archrival, UPS. The Atlanta-based carrier is expected to post its first quarter earnings Oct. 23.
“While UPS benefits from the same robust pricing as FedEx on the domestic ground side, it faces the same economic headwinds and trade down issues on the air side,” according to the Stifel Nicolaus report. “UPS also has a larger exposure to a slowdown in European consumption.”