FedEx Caught in Shift as Cheap Trumps Quick

Published by Bloomberg Businessweek

FedEx Corp. (FDX)’s falling volumes for its fastest, most-profitable services signal that shippers are increasingly deciding their packages no longer have to be there overnight — and not just in a slowing economy.

The operator of the world’s largest cargo airline may be seeing a more permanent change in its market, as customers turn to cheaper, slower ground deliveries and even ocean shipping. It’s an evolution that threatens to touch United Parcel Service Inc. (UPS) and Deutsche Post AG (DPW)’s DHL Worldwide Express, too.

“There has been a secular shift from ‘got to get it there overnight’ to more deferred products,” said Jeff Kauffman, a Sterne Agee & Leach Inc. analyst in New York. “Not because they can’t afford it, but because they are finding out the deferred choices are just as time specific.”

FedEx spotlighted the strains on its business yesterday when it cut its full-year profit forecast, sending the shares to their biggest drop since June 1. Quarterly volumes fell for premium delivery services in the U.S. and overseas, as shippers chose cheaper alternatives to having their goods packed onto jet freighters, the Memphis, Tennessee-based company said.

Chief Executive Officer Fred Smith pioneered the modern air-freight industry as he took an idea in one of his college essays and built it into the company he runs 41 years later. FedEx Express, the biggest unit, uses planes to expedite deliveries of goods ranging from electronics to pharmaceuticals.

‘Absolutely, Positively’

“When It Absolutely, Positively Has to Be There Overnight” became a pop-culture catchphrase starting in the 1970s as FedEx featured the trademarked slogan in ads emphasizing speed and reliability.

Now FedEx is under pressure from forces as varied as the economic slowdown in the U.S. and overseas and what Kauffman said is a growing number of customers that have never used overnight deliveries. Three- and four-day services meet many businesses’ needs, Kauffman said in an interview.

“You’re seeing a demand for slow instead of a demand for fast. That’s a structural change,” said David Vernon, a Sanford C. Bernstein & Co. analyst in New York. “You either create a service that takes more of that volume shift or you end up in a much worse position.”

FedEx will use an Oct. 9-10 investor meeting in Memphis to detail changes at FedEx Express that will take out “a significant amount of cost,” Smith told analysts yesterday on a conference call. He didn’t elaborate, and Jess Bunn, a spokesman, declined to comment beyond what was said on the call.

Market Transition

“This is an acknowledgment that the market that FedEx built its business on in the ’80s and ’90s has changed,” said Ben Hartford, a Robert W. Baird & Co. analyst in Milwaukee.

The company said in August it would offer voluntary buyouts as part of its savings plans. FedEx also is retiring 24 jet freighters and 43 older engines to match shipping volumes. It has said it expects to stop using 21 Boeing Co. (BA) 727s and replace them with more fuel-efficient 767-300 and 757-200 aircraft.

FedEx was unchanged at $86.55 at 9:59 a.m. in New York after yesterday’s 3.1 percent drop (FDX). Gains of 3.6 percent for FedEx and 0.4 percent for UPS this year (FDX) through yesterday trailed the 16 percent advance for the Standard & Poor’s 500 Index.

Kauffman recommends buying FedEx, while Hartford has an outperform rating on the stock and Vernon rates the shares as market perform.

China Fallout

Contracting economies in the U.S. and Europe have triggered a slump in international trade growth over the past several months, contributing to a drag on shipping demand and hurting economic growth in China, Smith said yesterday on the call.

“The locomotive that has driven China’s growth is its export industries, and with the situation in Europe and to a lesser degree in North America, that is a significant issue for the Chinese economy,” Smith said. “The consumer consumption in China is not increasing at a significant rate, contrary to everybody’s hopes.”

At the same time, FedEx has been adjusting product offerings, including expanding sea freight offerings through FedEx Trade Networks as that shipping business has grown. FedEx is an “increasingly big player in that segment,” Smith said.

While shipments of “very profitable” international priority packages dropped 2 percent in FedEx’s quarter ended Aug. 31, economy deliveries jumped 13 percent, FedEx Express CEO David Bronczek said on the call.

Volume Drop

Volumes among all categories of domestic shipments fell in the quarter from a year earlier. A cell-phone company that FedEx declined to identify shifted from all-Express shipments during the quarter to a combination of ground and SmartPost, a service for low-weight residential shipments in which the U.S. Postal Service provides final delivery.
Donald Broughton, an Avondale Partners LLC analyst based in St. Louis, said he believes the demand shift at FedEx is based on slowing economic growth, not a structural change within the shipping industry.

“In a slowdown, that’s what happens,” he said. “People cut back on costs. But when the economy rebounds, price matters less as volumes take off.”

The changes noted by FedEx will extend to UPS and DHL, said Broughton, who has a market perform rating (FDX) on FedEx and a market underperform on UPS (UPS), and doesn’t cover Bonn-based DHL parent Deutsche Post. UPS pared its annual profit forecast in July after second-quarter earnings trailed analyst estimates.

Global ‘Triopoly’

“Worldwide global air freight is a triopoly,” Broughton said. “It’s FedEx, UPS and DHL.”

Michael Mangeot, a spokesman for Atlanta-based UPS, said “trade down” has been an issue in recent years as customers have tightened budgets. Domestic air volumes at the world’s largest package-delivery company have risen in recent quarters, he said.

DHL didn’t return a telephone message seeking comment yesterday.

Dell Inc. (DELL) is among the companies changing shipping preferences as its business changes.

To save money, the Round Rock, Texas-based maker of personal computers is trying to sell more units with preset configurations instead of tailoring each PC to order. That saves money and allows Dell to send more cargo by sea instead of relying on costlier air service to ensure timely deliveries.

“Our ocean shipments year-over-year grew 60 percent,” President Jeff Clarke told analysts on a June 13 conference call. A spokesman, David Frink, declined to give a breakdown yesterday on the ocean-instead-of-air shift.

“Customers looking to save cost in a low-growth economy are moving toward deferred products,” said Anthony Gallo, a Baltimore-based analyst for Wells Fargo Securities LLC who rates FedEx as market perform. A long-term market transition is under way as well, he said in an interview.

“Shippers think differently about how they move products,” he said. “If your supply chain is predictable, then transit times are somewhat less important, as long as it shows up when it’s supposed to show up.”