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Why This Company's Brilliant Network Could Deliver Stock Gains

By Matthew Pelletier - Dec 8, 2013 at 9:15AM

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FedEx's shipping system has been designed and expanded to perfectly match its business needs.

With 1,200 operating stations and 10 air hubs worldwide, FedEx (FDX 0.77%) can deliver packages to people in more than 220 countries and every address in the United States. Its expansive network has helped FedEx enjoy continued success since its inception. But if it wants to maintain that growth, FedEx must still overcome several specific flaws lurking in this otherwise sturdy system.

Network design
The hub and spoke design of its shipping network -- a unique innovation when the company was founded -- helps set FedEx apart. All of the packages within a specific network are delivered directly to a predetermined hub. Once the packages are received at the hubs, they are sorted and combined with other orders to be shipped to similar destinations. Fuller shipments mean FedEx's plans and trucks need to make fewer trips, which allows FedEx to enjoy lower transportation costs, less inventory, and faster, more efficient operations.

FedEx Express built itself around this network, allowing the company to  ship products quickly with low costs to customers. The United States has several regional hubs, with FedEx's headquarters in Memphis, Tenn., referred to as the "SuperHub." This design gives FedEx an advantage over competitors, allowing it to adapt quickly to changing industry trends. 

Shift in customer preferences
Recently, customers have shifted away from express or overnight shipping toward slower but less expensive -- and lower-margin -- options. That's not great news for FedEx, since FedEx Express accounts for 61.4% of the company's total revenues. FedEx Express is certainly still growing, but margins can be heavily affected in the short-term if the company doesn't foresee or prepare for further customer moves toward less expensive options. 

FedEx is not the only company experiencing these issues. United Parcel Service (UPS -0.29%) was forced to pre-announce its earnings this July, due to a severe miss from analysts' estimates. Earnings missed in large part because of the shift toward lower-yield shipping options. In the quarterly earnings call, UPS management stated this industry trend may continue into the future.

As supply chains become more consistent, UPS said, manufacturers have a better ability to plan future shipments. Since they can better anticipate supply shortages in future operations, companies can take greater advantage of cheaper, slower shipping options, instead of having to pay more to ship goods at the last minute.

Also, UPS stated that as emerging markets rapidly expand their industries, moving from agriculture to manufacturing, international trade is becoming more regional. For example, countries within the southern hemisphere increased trading among themselves by 5% more per year than the world average.

FedEx's international network
To capitalize on this development, FedEx is focusing heavily on expanding its presence in international markets, with a focus on China, India, Europe, and Latin America. In the past year, the company has made strategic acquisitions of Polish, French, and Brazilian transportation and delivery companies to expand its network. Along with these acquisitions, FedEx opened 48 new stations across Europe.

FedEx also operates a powerful network of over 400 cities within mainland China, which it started serving in 1984. In 2009, the company opened its hub for its entire Asia-Pacific region in southern China. Last year, it announced the plans to build a new express and cargo hub in Shanghai by 2017. This investment is a long-term strategy to benefit from the continuous growth in the Chinese economy.

As FedEx's network expands across the world, it can leave the company vulnerable to sudden economic changes. A decrease in demand in one region of the world makes it increasingly difficult for the company to adjust its operations. Earlier this year, the company acknowledged that it moved too much capacity into Asia, based on lofty forecasts. Overestimating this demand contributed significantly to FedEx missing its fiscal third quarter EPS estimates by $0.25; shares fell into the $90s as a result.

Bottom Line
FedEx has grown an impressive 51% this year, and investors hope this growth can continue. There are always weaknesses within a global company, but FedEx has managed to overcome them thus far. The company has learned from poor results in recent quarters, which is a great sign for the future.

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Stocks Mentioned

United Parcel Service, Inc. Stock Quote
United Parcel Service, Inc.
$182.76 (-0.29%) $0.54
FedEx Corporation Stock Quote
FedEx Corporation
$245.12 (0.77%) $1.88

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