Despite Optimism, FedEx Corporation Faces Challenges

The freight forwarding and logistics companies generally perform well in an economic up-cycle, and FedEx (NYSE: FDX  )  is no exception. The stock is trading at an all-time high, and analysts expect there may be further upside. Oppenheimer recently raised the stock's price target from $161 to $168, which represents a potential upside of approximately 10% from the current level.

The International Monetary Fund (IMF) expects that economic activity will improve further in 2014-15, based on recovery in the advanced economies, which is certainly a bullish indicator for FedEx. However, amid this cheerful environment, the company is expected to see growing competition from DHL, a part of Deutsche Post DHL, and could experience contraction in its e-commerce business. 

Market share pressure from DHL?
The global logistics market has reached approximately $4 trillion in 2013, which is almost 10% of global GDP, according to a report from CandM Research. In terms of time-definite international shipping (TDI) market share, DHL is the global leader in the logistics market with 32% market share, followed by FedEx with a market share of 27%. However in the Americas, FedEx is the leader with 50% market share.

Source: DHL

DHL has returned to the U.S. again, six years after the German company left the country. Mike Parra, Deutsche Post's U.S. chief said DHL Express has begun winning new business among U.S.-based outfits that source goods and export their finished products abroad. In addition, DHL has also started to expand its service offerings for the life sciences and health care industry in the U.S. with the expansion of its Thermonet certified facilities. Temperature-controlled shipping in the industry has become increasingly important in recent years. DHL Thermonet provides seamless temperature visibility along the supply chain with 24/7 proactive monitoring. FedEx also offers temperature-controlled shipping for the industry, which could see intensifying competition from DHL.  

DHL can certainly become a threat to the U.S. freight forwarding and logistics companies, including FedEx and United Parcel Service  (NYSE: UPS  ) , as the company is embarking on a major expansion with plans to double its U.S. sales force over the next two years.

While DHL has its global network covering more than 220 nations, FedEx and UPS also offer international services in most of the 220 nations DHL covers. It is expected that FedEx's recently announced pricing strategy will make it difficult for DHL to steal market share from the company. The company announced in May that effective January 1, 2015, it would charge customers for its ground services by "dimensional weight," which means charging based on package size in addition to weight.  

The new pricing strategy will help FedEx charge higher rates for packages that are bulky-yet-light. Although the strategy could translate into higher shipping costs for some customers, such as web shoppers, it's expected to generate higher overall revenue for FedEx. The strategy could also lead to better price realization, boosting FedEx's operating margin. 

Following FedEx, UPS just announced that it would start charging by size of packages for all ground services in the U.S. effective December 29, 2014. Currently FedEx charges its express customers based on "dimensional weight." The "dimensional weight" policy is also applied to ground customers for packages larger than three cubic feet, which the company intends to extend to all ground packages.

FedEx's e-commerce business may see contraction
The "dimensional weight" policy is expected to hurt e-retailers the most, such as Amazon.com  (NASDAQ: AMZN  ) , and these retailers have to come up with ways to counter the effect of such pricing policy on their operating margins.  However, it seems that there is no way around immediately. DHL could be a better option for them in the near term. DHL's Mike Parra said Uncle Sam is the company's largest customer, followed by major global shippers like Amazon.com.

FedEx's e-commerce business is growing rapidly. The company said its fiscal Q4 profit rose sharply because of growing e-commerce sales. However, DHL's entry in the U.S. market could derail FedEx's e-commerce growth engine significantly.

Moreover, Amazon is starting to deliver its own packages, which can give the e-retailer more control over the shopping experience; it will also help the company contain shipping expenses in the long run. The move is expected to hurt both FedEx and UPS, which now deliver the majority of Amazon's packages. However, it's difficult to estimate exactly how much of FedEx's revenues would be lost. If FedEx wants to retain its business from Amazon, it would rather give Amazon a sizable discount.  

Foolish bottom line
DHL left the U.S. market for domestic-only shipments because of heavy losses during the financial crisis of 2008. Meanwhile, FedEx recovered its lost ground post the financial crisis substantially. Now it remains to be seen if DHL succeeds again in the U.S. amid an extremely tough competitive environment. For FedEx, its new pricing policy could provide the company an advantage over DHL, although the company could see significant contraction in its growing e-commerce business. For investors, FedEx is perhaps a "wait and watch" stock. 

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