After its breathtaking 60% run-up in 2013, many analysts thought FedEx (NYSE:FDX) stock might take a breather in 2014. Yet the shipping and logistics giant nearly doubled the S&P 500's return, racking up a more than 20% gain on the back of an effective profit improvement program, growing global trade, and ballooning e-commerce sales. With a formidable transportation network in place and new opportunities on the horizon, there's reason to believe FedEx stock might pull a hat trick in 2015.
Leaner and meaner
FedEx is in the middle of an ambitious restructuring plan to improve profitability by $1.6 billion annually by 2016. The company has already made impressive strides in increasing efficiency through better matching its network capacity to customer demands, modernizing its air fleet, and driving employee productivity through voluntary buyouts of certain positions and merit pay increases for others. While maintenance and payroll expenses have been significant during the restructuring, FedEx expects the efficiency and productivity gains to the bottom line to accrue primarily in 2015 and 2016, meaning the company is just now turning the corner toward reaping benefits from this program.
A major part of the initiative to manage network capacity for maximum yield is a new pricing schedule that took effect on Jan. 1. Previously, FedEx Ground charged customers to ship any packages smaller than three cubic feet solely by weight, so very light but bulky packages, such as toilet paper, did not bring in much revenue yet took up a disproportionate amount of physical space in the company's vehicles. Now, FedEx will price all Ground packages according to dimension, effectively raising rates on less-dense packages.
Is USPS really a rival?
After FedEx announced this change, the United States Postal Service declared that it would reduce pricing on lighter packages to be more competitive and take market share, particularly in e-commerce deliveries. However, the two parcel delivery services are not just competitors; they're also mutual customers.
The Postal Service's network specializes in the "last mile," getting a delivery from the final hub location to a customer's address. This is labor intensive, requiring an employee to visit every door, often with light-duty trucks that specialize in low-weight packages. FedEx is more famous for its fleet of planes and its logistics centers, making heavier-weight, higher-value traffic the company's "sweet spot." These networks have such complementary strengths that the Postal Service uses FedEx to fly Priority Mail and Express Mail parcels between airports, while FedEx relies on USPS last-mile delivery capabilities for its own SmartPost service. So as a customer of the Postal Service's low-weight home delivery, as well as a competitor, the final effect on FedEx from the USPS rate reduction is not yet clear.
As FedEx's own price hikes indicate, however, the company might not mind losing volume share in the low-value, low-weight delivery market, if that means it could generate a more favorable profit mix, which is in line with its profit improvement program. Shortly after the Postal Service announced its price cut, FedEx CFO Alan Graf said the company's decision to introduce dimensional pricing was made independent of competitors, with the primary goal being to encourage shippers to use smaller, denser, and more efficient packaging. To that end, the company has made a packaging lab available to customers to help them design streamlined shipping options. This doesn't just look good for FedEx's sustainability image, it also helps to free up valuable space in its network, further driving the company's efficiency and profitability goals.
Coasting on cheap fuel
While the motor of FedEx's great performance has truly been its profit improvement program, a far more flashier news item for the company has been the low cost of oil. As it's the operator of hundreds of aircraft and tens of thousands of trucks, it's easy to assume cheaper fuel would be a massive boon to FedEx's bottom line, which is exactly what some analysts did, estimating second-quarter earnings higher than actual results. While it's true that cheaper fuel means lower expenses for FedEx, cheaper fuel also means less revenue collected from customers via the company's fuel surcharge. That means FedEx benefits only modestly when prices fall.
FedEx also does not respond rapidly to fuel price changes. It contracts its fuel purchases based on index prices that reflect the previous week's or even the previous month's fuel price. It assesses its fuel surcharges to customers, meanwhile, on a six- to eight-week lag. However, should oil prices remain low for an extended period, FedEx will benefit more considerably. Not only will the company spend less on fuel, but lower fuel surcharges might encourage customers to upgrade to faster, more profitable shipping options. In all, cheap fuel should be seen as a modest tailwind for FedEx in 2015, with the opportunity for real market-beating returns coming from the continued execution of its restructuring plan.