FedEx Focuses On Improving Margins In A Slowing Economy

by Trefis Team
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FedEx (NYSE:FDX) has set a goal to improve its profits by $1.7 billion annually within the next three years. [1] This implies an operating margin which exceeds 10%, compared to an operating margin of 7.5% for the company in the fiscal year ended May 31, 2012. [2] The company intends to achieve this steep task by initiating several cost cutting measures. These measures include reducing the size of its network, replacing old aircraft and delivery trucks in its fleet with new fuel-efficient ones, and driving up its employee efficiency. The management of the company opted for a margin focused path to achieve growth in earnings per share (EPS), as a slowing global economy was not allowing for high top line growth.

In addition, over the past few quarters, the company has also seen a steady shift in demand from its air-based Express services to its ground-based services and sea borne shipping. Thus, to better align its network with the altered demand scenario of the industry, FedEx will implement most of these cuts in its FedEx Express and FedEx Services segment. The latter is a small business unit of the company involved in providing sales, marketing, IT, communications, customer service and certain other back-office support to rest of the company.

However, in implementing these changes the management will have to be careful that a downsizing of the network does not hamper revenue growth, and other cuts do not compromise on package safety and customer service. We currently have a stock price estimate of $98 for FedEx, nearly 10% above its current market price.

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Details of the cost cutting program

FedEx targets $700 million in savings from optimizing its network operations. Out of this, $350 million shall be from domestic U.S. operations through consolidating stations and routes, and another $350 million from international network operations. It targets $300 million in savings by replacing its old aircrafts and trucks with new fuel-efficient ones, and $400 million by improving staff efficiency and removing redundancies. Another $150 million in savings is targeted by way of yield management. [3]

In June earlier this year, FedEx had announced that it retired 24 cargo planes and 43 engines to match demand. The company also plans to retire 21 Boeing 727s in the current fiscal year. Those aircraft will be replaced with Boeing 767-300 and 757-200 aircraft that are more fuel efficient and have lower maintenance costs as well. It also ordered 21 767s, to be delivered through 2017, replacing Boeing MD-10s and Airbus A310 models. [2] According to the company, the twin-engine 767s will be about 30 percent more fuel-efficient than the three-engine MD-10s. With regard to improving staff efficiencies, the company plans to leverage its IT systems.

However, in its cost-cutting spree the management shall have to strike a rather difficult balance between network optimization and revenue growth. And, other cost cutting measures particularly those related to administrative operations should not impact customer service and safety of packages.

The company also plans to raise its dividend payout. [1] Currently, it pays 14 cents a share, equaling a low dividend yield of 0.62%. [4] All in all, FedEx’s focus on improving margins in a slowing global economy is a step in the right direction. And, if it is able to achieve the stated profit growth target it will benefit over the long-term by means of low cost structures, and its investors will surely benefit in the process.

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Notes:
  1. FedEx Announces Programs Targeting $1.7 Billion In Annual Profit Improvement by End of Fiscal 2016, October 9 2012, news.van.fedex.com [] []
  2. 10-K for fiscal year ended May 31 2012, www.fedex.com [] []
  3. FedEx provides details of major cost-cutting plan, shares rise more than 5 percent, October 10 2012, www.washingtonpost.com []
  4. FedEx Corporation, www.google.com/finance []
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