Why Lower Energy Prices Hurt FedEx
FedEx has an indexed fuel surcharge for U.S. domestic and U.S. outbound shipments, with different trigger points for the type of service used by the customer: The fuel surcharge percentage for FedEx Express services is subject to monthly adjustment based on a rounded average of the U.S. Gulf Coast (USGC) spot price for a gallon of kerosene-type jet fuel; the fuel surcharge percentage for FedEx Ground services is subject to monthly adjustment based on a rounded average of the national U.S. on-highway average price for a gallon of diesel fuel.
Lower fuel surcharges are directly tied to lower fuel prices. For example, as illustrated in the figure to the right, the average cost per gallon of jet fuel was at a historical high of $4.06 in the first-quarter of 2009 compared with $1.91 in the most recent quarter. Ergo, the weighted-average U.S. domestic and outbound fuel surcharge was 31.7% in the first quarter of 2009 versus 3.3% in the first quarter of 2010, according to the 10-Q earnings filing.
During the earnings call with analysts, chairman and chief executive Frederick Smith optimistically predicted that the U.S. economy would return to growth in 2010, growing three percent in the company’s third-quarter and 4.9 percent in the fourth-quarter (ending May 31, 2010). FedEx Express service plans to increase shipping rates by an average of 5.9% for U.S. domestic and U.S. export services, effective January 4, 2010. However, the rate increase will be partially offset by adjusting the fuel price at which the fuel surcharge begins, resulting in a two percent reduction in the fuel surcharge, Smith said. Additional rate and surcharge changes will also be made to other FedEx services, such as FedEx Ground, with specifics to be announced later this year.
In its core U.S. small-package business, FedEx competes primarily with UPS. As the two rivals offer nearly identical complements of ground and express services, price is often the deciding factor for the business customer. Given the recession, overcapacity has plagued the industry, resulting in heavy discounting as competitors — large and small — scrambled to protect market share. For example, FedEx Express revenue per package plummeted year-on-year 22.5% to $18.76 (see figure above).
The company does not rely anymore on fuel hedges to mitigate volatility in fuel prices, choosing instead to focus on surcharges. If Smith and company misjudge the timing and pace of the U.S. and global economic recovery, the attempt at priming revenue through fuel surcharge hikes could backfire, in my opinion. If the purchasing power of folks and businesses alike do not recover, especially here at home, the higher costs being passed on to them by FedEx could push these customers away from the higher-yielding express services (about 62 percent of total sales) to the lower-yielding ground services (about 20 percent of total sales) — or even worse, reduce demand for packaged-delivery services altogether. Such a scenario was in evidence in the first-quarter of 2009, when the soft U.S. economy, higher fuel prices, and higher fuel surcharges led to a substantial decline in U.S. domestic express shipments.
Image Sources: FedEx Corp Form 10-Q (Quarterly Period-Ended August 31, 2009)
BNET User Analysis