FedEx is to ground more aircraft and further reduce its air capacity to and from Asia in a bid toshore up profits at its Express division, which declined by two-thirds in the three months to 28
February, the company revealed today.Overall third-quarter group revenue grew by 4 per cent to US$11 billion, but group operatingincome dropped by 28 per cent to $589 million, mainly because of the decline in profits at FedExExpress “due to the accelerating demand shift toward lower-yielding international services andlower international export yields”, the company said.
Within FedEx Express, revenue was up 2 per cent to $6.7 billion, but operating incomeplummeted 66 per cent to $118 million, with operating margin dropping from to 1.8 per cent, from5.3 per cent the previous year.
The overall group operating margin of 5.4 per cent was down from 7.7 per cent the previousyear, while net income of $361 million was down 31 per cent from $521 million a year ago. Thecompany said its third-quarter results were also negatively impacted by costs stemming from thecompany’s business realignment programme, announced last October and by one or two fewer operatingdays.
Alan Graf, executive vice president and chief financial officer, said the group’s Ground andFreight divisions had “continued to post solid results”, but the group’s overalllower-than-expected results for the quarter and reduced full-year earnings outlook “were driven bythird-quarter international revenues declining approximately $100 million versus our guidance,primarily due to accelerating customer preference for lower-yielding international services andlower rates per pound and weight per shipment”.
He said the company expected these international revenue trends to continue and had put inplace “other actions beyond those already included in our profit-improvement programme”, the $1.6billion initiative announced last October, to address the issues within the group’s Expressdivision. “Some of these additional actions may involve temporarily or permanently groundingaircraft, which could result in asset impairment or other charges in future periods,” Graf added.
Chairman, president and CEO Fred Smith admitted to analysts and journalists today that FedExExpress had left itself over-dependent on carrying lower-yielding air freight volumes in itsintercontinental freighters out of Asia, a market that had been increasingly suffering from volumedecline, over-capacity and yield erosion.
“The international express business is still growing: the door-to-door part of thebusiness,” Smith said. “It is the air cargo market, which has been adversely affected by lowereconomic growth around the world caused by the policy choices that are now reflected in theEuropean situation and relatively low growth in the United States, and China’s situation.
“I think the bottom line is that we got a little bit ahead of our skis, and we have morecapacity in the heavier, more cost-sensitive air freight market, and what we are now doing now isadjusting capacity back so it is more focused on International Priority, where our network is quiteunique and has a competitive advantage.”
Smith described the third quarter as “very challenging, due to continued weakness ininternational air freight markets, pressure on yields due to industry overcapacity and customersselecting less expensive and slower-transit services. In response, beginning 1 April, FedEx Expresswill decrease capacity to and from Asia and will aggressively manage traffic flows to place lowyielding traffic in lower-cost networks.”
He said the company was assessing how these actions may allow FedEx Express to retire more ofits older, less-efficient aircraft, but that the company remained focused on its strategiccost-reduction programmes, “which are ramping up and on track”.
Revenue within FedEx Express increased due to business acquisitions and growth at FedEx TradeNetworks, while core express revenue was constrained by continued demand shift towardlower-yielding international services. US domestic revenue per package grew 1 per cent, as higherrates per kilogramme and weight per package were offset by lower fuel surcharges, while averagedaily package volume increased 1 per cent.
Higher growth in international deferred services continued, with FedEx International Economyvolumes growing 12 per cent, while FedEx International Priority volume increased 2 per cent duringthe quarter. However, international export revenue per package fell 3 per cent due to the demandshift to lower-yielding international services, lower rates and lower fuel surcharges.
Operating income and margin within FedEx Express were significantly lower due to the demandshift to lower-yielding international services, the prior-year reversal of a $66 million reserveassociated with a legal matter, the negative impact of one fewer operating day, higher pension costand increased depreciation expense, the company said. Costs associated with the businessrealignment program also negatively impacted operating results by $34 million.
David Bronczek, president and CEO of FedEx Express, commented: “It is the air freight marketwhere there is overcapacity, and because of that, people are looking for a market shift in theirpricing. The issue for us is not that we don’t have enough volume – we have too much volume in thewrong product, in the wrong network.”
Bronczek said this was illustrated by the fact that volumes of deferred packages carried byFedEx Express were up by 12 per cent. “We had to cap that, because our planes coming out of Asiawere full,” he explained. “But they were full of the wrong type of product.
“So, we’re moving the traffic into a low-cost network, we are opening up our expressfreighters for truly IP, international priority traffic, and we’re bringing down our cost of thecapacity. When we look at the marketplace, it has shifted. Right now, until the marketplacecorrects itself in terms of global capacity, we are taking the lead for our business.”
Bronczek stressed that FedEx Express’s IP parcels actually grew by 2 per cent. “The issue isthat we’ve got this big lane imbalance between Asia and the United States and this keeps drivingitself farther and farther. Our goal is to take advantage of our global network, and where we havemultiple airplanes in some markets, pull them out, and force the traffic that is trulyinternational priority onto our planes, move into a low-cost network some of these low yieldingpackages, and get more lane balance into our network around the world.”
He said that the company had a lot of opportunities beyond Asia to the United States. “Weare looking at Asia to Europe and back again, for example,” he added. “So when you look, in a lotof the marketplace, we have had a lot of growth. But in terms of airplanes, because of the pulldown in the international market there, we’re looking at ways to retire older, morefuel-inefficient and maintenance-inefficient aircraft sooner.”
Graf said the company was already seeing the benefit of restructuring changes that had beentaking place since last October, “flying fewer pounds at higher yields in the fourth quarterguidance, and that will continue into 2014”.
The CFO added: “Express’s performance in Q4, year over year, will be a whole lot better thanin Q3 and there has been a lot of cost cuts that have already been done ahead of schedule.”
Graf said the capacity changes currently being finalised for Express were expected to be inplace for the medium term. “Express’s aircraft capital expenditures over the next few years arelargely replacement, and if anything we’re going to accelerate that, because if we make anyelections to retire aeroplanes, they will be older aircraft that have higher fuel burn andmaintenance requirements,” he said.
“So those capital investments we still want to make because they still have a high ROIC:We’re not tkaing but a couple of B777s over the next serveral years. Most of those been shoved wayback. So whatever we come up with, it will be the size of the fleet that we will flyinternationally for at least two or three years.”
Asked about how FedEx saw the market in Europe, following the collapse of UPS’s attempt tobuy TNT, Bronczek said: “Our European organic strategy we put in place around 18 months ago hasbeen performing exceptionally well. We’ve opened 70 stations in Europe, and by the end of thisfiscal year it will be 87, and that is over a two-year period of time.” He said service levels andvolumes were growing well, and that Asia and Europe were leading the way for international exports.
“So we’re very comfortable with our position in Europe right now,” he insisted. “The marketsare tough. Obviously we won’t talk about acquisition opportunities for a lot of good reasons. Butour European team is doing great job; we’re very happy with their results.”
