In a previous article, I discussed the three big trends that have changed the nature of end-market demand for FedEx Corporation (FDX +4.03%) and United Parcel Service (UPS +1.86%) since the last recession: booming e-commerce demand, increasing protectionism that's slowing the growth of world trade, and customer preferences for cheaper, less time-sensitive deliveries. All three trends are affecting both companies, and both have had to make significant operational changes in response. The question is whether these changes have fundamentally affected profitability. I previously discussed UPS in this regard, and now it's time to take a closer look at FedEx.
Productivity and operating income
I'm going to use return on assets, or ROA, as a measure of productivity. In this case, ROA is simply segmental profits divided by segmental assets. Looking at matters from a segmental perspective is a good idea, because it shows how FedEx is dealing with the various business trends I mentioned.
And there's little doubt that the changes have been significant. For example, a look at operating income by segment shows how dramatic the shift toward ground-based revenue (primarily driven by increases in e-commerce and preferences toward cheaper delivery options) has been.
Before the 2008-2009 recession, FedEx used to make the bulk of its operating income from its Express segment, but the Ground segment has taken the lead:
Source: FedEx Corporation presentations.
Has it changed productivity for FedEx?
In a previous article on UPS, I looked at segmental ROA and concluded that although UPS has clearly made investments in upgrading its network, there hasn't been an underlying change in productivity at its U.S Domestic Package segment. However, its International Package segment does appear to have become a bit less productive -- possibly a consequence of relatively slower growth in world trade since the recession.
UPS' problem in recent years has been more about dealing with peak demand periods during the holiday season -- something that one hopes the company can deal with in future years. Having discussed UPS, how does FedEx measure up?
Here's a look at FedEx's segmental ROA since the recession. Ground ROA has held up well, as the company has done a better job of dealing with peak demand periods created by burgeoning e-commerce demand -- but there's been a clear drop in Express ROA. Moreover, it's taken a while for Freight ROA to recover.
Source: FedEx Corporation presentations.
What it all means
These charts reveal a mixed picture. On one hand, the Express segment looks as if its productivity has fallen since the recession, and this is probably a consequence of a slower growth pace in global trade than might be expected historically. However, the good news is that it doesn't matter so much, because profits at its Ground segment have more than offset the declining importance of the Express segment.
On an even more positive note, thus far, FedEx's Ground ROA has held up well, despite the pressure that peak demand has put on the Ground network. This is important, because FedEx needs its Ground segment to offset the profitability decline at Express since the recession.
Dimensional weight pricing; profit improvement program
Moreover, there are two initiatives that look likely to help FedEx in the future. First, UPS and FedEx have both expanded their usage of dimensional weight pricing -- a method of pricing packages based on dimensions as well as weight. It's an important move, because as UPS' management recently outlined, it will encourage customers to package their deliveries more efficiently -- something that should help UPS and FedEx deliver more efficiently as well. The early indications are that the initiative is working.
Second, FedEx is in the middle of implementing a profit improvement program that should lead to a $1.6 billion increase in profitability by the end of 2016. Indeed, FedEx's management recently affirmed that the program was on track.
The takeaway
All told, FedEx has seen a negative impact on productivity at its Express segment, but that's been offset by continued strong performance from its Ground segment. In addition, FedEx has taken initiatives to boost productivity at its Express segment in future years -- good news going forward. Meanwhile, dimensional weight pricing should help Ground productivity for FedEx and UPS in the future. It's always challenging dealing with changes in end markets, but FedEx appears to be on the right track.
