In Order to Save Gas, FedEx Steps on the Gas

Last year, FedEx (NYSE: FDX  ) unveiled a plan to boost profitability by better aligning its cost structure with global demand, which has remained subdued ever since the Great Recession. The restructuring entailed three main programs: rationalizing the FedEx Express network by eliminating unprofitable capacity; reducing staffing costs through a voluntary buyout program; and replacing outdated aircraft with newer, more efficient models.

Removing old aircraft from the FedEx Express fleet offers the prospect of significant long-term cost savings for the company. Like most cargo companies, FedEx uses planes that are older (on average) than a typical passenger airline's fleet. However, that means it still operates many outdated, gas-guzzling aircraft like the Airbus A300, Airbus A310, Boeing (NYSE: BA  ) 727, and MD-10. These aircraft also have higher maintenance costs than their modern equivalents, due to their age.

This week, FedEx decided that in order to save fuel, it needed to step on the gas by accelerating its fleet restructuring program. FedEx recently retired 10 older aircraft (A310s and MD-10s) earlier than scheduled, and the company will move up the retirement dates for 76 more planes of those two types. By removing these older aircraft from the fleet earlier than scheduled, FedEx will save hundreds of millions of dollars in fuel and maintenance costs. This is a big positive for shareholders.

Aggressive restructuring bodes well for profit
In its most recent quarterly report, FedEx reported that global air freight demand remained sluggish. The company therefore announced capacity cuts in its FedEx Express Asian network. At the time, FedEx founder and CEO Fred Smith stated that -- based on the newly implemented capacity reductions -- the company was looking into the possibility of accelerating the retirement of older aircraft.

This week's announcement demonstrates that FedEx's management team was able to meet that goal. In order to accelerate its aircraft retirements, FedEx will take a $100 million charge for the recently ended quarter. The retirements will also lead to an additional $74 million of accelerated depreciation in the next year.

This is a relatively small cost to bear in light of the significant savings FedEx will achieve going forward. Just last quarter, the FedEx Express segment incurred fuel costs of more than $1 billion, along with maintenance expense of $262 million. FedEx has stated that the Boeing 767 planes that it is buying offer a 20% cost improvement over the MD-10 aircraft they are replacing. Moreover, the company probably got a very good price from Boeing for the 50 767s it has ordered, as FedEx is singlehandedly keeping the 767 production line going.

Furthermore, the previously announced capacity reductions at FedEx Express made some of the retiring aircraft superfluous. By permanently grounding them, FedEx can avoid costly maintenance work, while maximizing utilization of the most cost-efficient airplanes in its fleet.

Realism is good for shareholders
In a perfect world, shareholders would like to see robust cargo demand growth that would prevent FedEx from retiring older aircraft ahead of schedule. However, for too many years, FedEx has focused on growing its network, in order to meet expected demand growth that did not always materialize. This resulted in an unsustainably high cost structure at the company's FedEx Express subsidiary.

Today, FedEx management has adopted a more realistic viewpoint: Global demand growth will be slow for the foreseeable future. This newfound realism will be good for FedEx shareholders. FedEx's top-line growth may be modest, but management is turning this into an opportunity to reduce the company's cost structure by at least $1.7 billion. This should drive significant profit growth over the next two years, leading to a revival of FedEx's fortunes.

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