FedEx to hike 2013 rates 3.9 percent on air products

The announcement came as FedEx officially disclosed its fiscal first quarter results, which it had telegraphed to the market two weeks before. The company reported revenue of $10.79 billion, up 3 percent from the year-earlier period. Operating margins and net income were down year-over-year.

The company doesn't expect the pressure to ease in its fiscal second quarter, which has just started. Instead, the company estimates earnings to come in between $1.30 and $1.45 per diluted share in the second quarter. For the same quarter a year ago, it reported earnings of $1.57 per diluted share. Fully diluted shares are defined as the total number of shares that would be outstanding if all possible sources of conversion, such as convertible bonds and stock options, were exercised and became common shares.

For its 2013 fiscal year, which ends next May, the company projected earnings in a range of $6.20 to $6.50 per diluted share, down from a range of $6.90 to $7.40 per diluted share. Both fiscal second quarter and full year forecasts are below most analysts' estimates.

The company said its projections assume jet and diesel fuel prices remaining at or near current levels, and excludes the impact of savings expected to be realized from initiatives designed to cut costs at its FedEx Express air and international unit.

DEMAND DOWN FOR AIR SHIPMENTS
Not surprisingly, the fly in the FedEx ointment is FedEx Express, the company's largest unit accounting for about 60 percent of its revenue. In the first quarter, revenue at the unit rose 1 percent year-over-year. However, operating income dropped 28 percent over the same period, while operating margins declined 4.4 percent.

The unit has been struggling for a long time with a multi-year transition in domestic transportation patterns. Value-conscious shippers are increasingly building out regional warehousing and distribution networks that can be supported by less-costly ground transportation. This means fewer goods need to move on expensive equipment like airplanes.

FedEx reported a decline in domestic non-next-day deliveries, known in company lingo as "deferred" deliveries. Company executives attributed about half of that decline to a large customer downshifting its business to ground deliveries and to an even lower-cost option known as "SmartPost," operated in conjunction with the U.S. Postal Service. FedEx wouldn't identify the customer, but an industry source said it was a large cell-phone provider.

The problems at FedEx Express aren't confined to the United States. In recent months, international air traffic has declined as China, the world's largest single-country exporter, has seen demand wane in Europe and, to a lesser extent, the United States. While U.S. exports to China have been holding their own, the volume is dwarfed by the amount of traffic coming from the other direction.

"I've been somewhat amused by observers who have underestimated the impact of China's exports on the global economy," said Frederick W. Smith, FedEx's founder, chairman, president, and CEO, on an analyst conference call yesterday.

To better align its operations with the changing demand for airfreight, the company has embarked on a significant cost-reduction program for FedEx Express that it will make public Oct. 9 and 10 in Memphis, Tenn. On yesterday's call, Smith bristled at the description of the initiative as a "restructuring," arguing there are no plans for layoffs or other "draconian steps."

He claimed the marketplace will be "surprised by the magnitude" of costs the company plans to shed from its air network, much of it coming from the reconfiguring of linehaul operations and the support infrastructure.

In a research note, William Greene, lead transport analyst at Morgan Stanley & Co., said that investors will expect "significant" cost reductions coming out of the two-day meeting in October. Currently FedEx's share price is roughly flat compared to where it was in June, when projections for full-year earnings were 10 percent higher. "We worry that these expectations may be hard to meet," Greene wrote.

Jeffrey Kauffman, transport analyst for Sterne Agee, said FedEx is coping with a combination of secular and cyclical trends. Kauffman noted that the domestic overnight express market hasn't grown since 2000, while the shift in international trade from air to ocean has been going on since 2007. Those long-term trends have been amplified by what Kauffman called a "cyclical growth slowdown" that has prompted retailers to draw down existing inventory levels rather than place new orders.

The company's two other principal units, ground parcel carrier FedEx Ground and less-than-truckload (LTL) carrier FedEx Freight, posted decent-to-solid results in the quarter. FedEx Ground showed revenue and operating income gains of 8 and 9 percent, respectively, over the year-earlier period. But the performance of both units was not enough to offset the subpar results at FedEx Express, especially in demand for its "priority" air services that command a premium price.

Smith said decisions by shippers to "trade down" to slower, less-costly services are due in part to the sluggish macroeconomic environment. Smith added that more commerce will return to the priority segment once businesses are more certain that U.S. and global economies have improved. In the meantime, the two trucking units are beneficiaries of the cautious stance of many FedEx customers.

Smith said the bigger challenge is the escalating price of oil, which makes shipping and transporting goods significantly more expensive. The relentless rise in energy costs has slowed overall economic growth, while forcing businesses to look for cheaper alternatives to air, such as surface transport in shorter-haul markets and ocean freight on long-range, intercontinental lanes, Smith said.

Smith said rising fuel prices has been the one variable that the company couldn't predict and the one that has wrought the biggest change. "The world economy has absorbed a tremendous increase in the price of fuel in the past 10 years," he said.

According to data from the Department of Energy's Energy Information Administration (EIA), the spot market price for jet fuel on Sept. 18, 2002 stood at 81.5 cents a gallon. On Sept. 11, 2012, the price hit $3.257 a gallon, a fourfold increase almost down to the last digit.