Adapting to lower shipping priorities
The top two integrators are facing a sea change brought on by international shippers choosing to delay express shipments by one or two days to save money.
While this trade-down of shipment priority isn’t hurting the overall shipment volumes at UPS or FedEx, declining revenue per package is forcing both carriers to reconsider their current business strategies.
UPS finished the second quarter with decreases in both operating profit and margin, but saw an increase in average volume per day. FedEx saw declines in both operating income and margin.
In FedEx’s second quarter earnings report, Chief Executive Officer Fred Smith referenced “customer preference for less costly international shipping services” as one of the major reasons for sluggish results. Before that revelation, the integrator had chosen to immediately retire 10 planes and accelerate the retirement for 76 MD-10 and Airbus 310 aircraft. The retirements aren’t necessarily about reducing capacity, but mean FedEx is focused on bringing in younger, more fuel-efficient planes ahead of schedule to reduce rising operation costs.
In its earnings report, FedEx also predicted a continued move away from expedited services by shippers, and plans to counter the current shipping environment by reducing capacity between Asia and the United States in July.
UPS is going through the same struggles, noting shipper preferences impacted the integrator’s international business in the second quarter. Officials saw a 3.4 percent decline in export revenue per piece during the second quarter, though daily export shipments rose 5 percent, year over year. In the second quarter, international package operating margin at UPS declined nearly half a percent, year over year.
UPS results, which were below expectations, have lead officials to say they are focusing on the company’s long-term strategy, which will certainly include finding ways to mitigate a trade-down in shipment speed by customers.
The integrators will now have to adjust to this new normal in shipping, according to Kevin Sterling, a senior vice president covering the air freight sector for BB&T Capital Markets. Both carriers have to find some way to take out more costs to make up for declining revenue per package, but FedEx, being the largest cargo airline, is facing an especially tricky issue as the price of operating planes has increased, but the amount of money being taken in isn’t, he said.
Both integrators have experienced boosts in their deferred products.
“Customers are now much better managing their supply chains,” he said. “Even though inventory positions are lean, the shippers are doing a great job managing their inventory positions.”
If the economy picks up, the trend of slowing shipment speeds may turn around, Sterling said, because shippers will be willing to pay more to get their goods to market. If the economy remains slow, shippers will be happy to keep things the way they are.
“(Express shipping) will pick up, but when I say the new normal, even if there is a spike, it’s probably a temporary spike,” he said. “From a shipper’s’ perspective, they see if they take costs out of their supply chain, they still get stuff on shelves in a timely manner.”
Express shipments will still be in demand for some industries. Pharmaceuticals and other cold-chain goods, as well as high-value cargo; need expedited shipping. Also, product launches — for the inevitable new version of the iPhone or next must-have gadget, for example — will almost always be shipped by express air cargo because time to market is critical.
There is a cyclical component to the declining priority shipments. In the dog days of summer, it isn’t as necessary for shippers to move their goods as quickly. But this is more than a mere seasonal adjustment in shipping volumes, Sterling said.
Moving forward, Sterling noted FedEx is spending roughly $4 billion each year on new planes to take costs out of its fleet and this is one of those aspects of the new shipping world the integrator can actually control. For now, the carriers don’t have an answer to how to bring back expedited revenue. They are simply analyzing their operating costs and making changes where applicable. But the carriers must be careful not to take out too much capacity when retiring planes before replacements are ready.
“If you take out too much capacity, your service starts deteriorating and they’re going to lose business,” Sterling said. “It’s a balancing act… to take out costs but to try to maintain that service.”
Striking this balance is important because the shipping shift could open the door for competitors to UPS and FedEx. Specialized carriers may be able to pick up some of the slack, and DHL certainly has this issue on its mind, Sterling said. DHL isn’t as asset-intensive as UPS or FedEx, so even though the European integrator is also seeing declining revenue-per-piece, it doesn’t feel it as much.
To emphasize his point, Sterling said while UPS and FedEx have cut their respective earnings guidance due to the demand shift, DHL has increased its earnings outlook. DHL saw a 2 percent rise in adjusted revenues, year over year, in the second quarter, but this was due primarily to an uptick in German mail activity, the company said. Earnings at DHL are expected to rise by 13 to 15 percent over the next two years.
The trade-down in shipments isn’t the only source of pain at UPS and FedEx. UPS has been affected by the general slowdown in the domestic U.S. economy, and both integrators are hurting due to declining industrial activity. The delay in shipments occurring, however, is the one thing that’s likely to change how FedEx and UPS do business moving forward, and Sterling sees both integrators moving swiftly to reorganize their operations.
“I don’t think the integrators — at least FedEx and UPS — have faced this type of structural issue in a while. They’re trying to adjust to it quickly, and I know it’s taking a lot of their attention,” he said. “They’re laser-focused on it.”