FedEx Says Retailers Should Be Paying More for Web Delivery
Expanding delivery network for e-commerce is costly, CEO says
“There’s an enormous interest in people having things delivered to themselves. It does not change, one iota, the input costs of the delivery,” Chief Executive Fred Smith said in an interview.
FedEx this year increased its capital spending to $4.8 billion, with the largest increase in its ground division which handles most of its e-commerce business, and intends to continue the increases in the next two years.
FedEx Chief Financial Officer Alan Graf said that it is important for the price of shipping an e-commerce package to reflect the effort it takes to deliver it. “We can’t build these networks and spend this kind of capital and not get a return on it,” Mr. Graf said in an interview.
The executives’ remarks came as the Memphis, Tenn., delivery giant reported third-quarter net income fell 19% to $507 million for the period ended Feb. 29, due largely to settling 19 lawsuits regarding its former independent-contractor driver model at its ground segment for $204 million.
Before the latest results, the stock had fallen 19% over the past year, hurt by unexpected legal costs, higher spending for expansion, a rough holiday season and worries about Amazon.com Inc. AMZN -2.58 % becoming a competitor to the delivery giant.
Just because Amazon has created a network of warehouses to support its retail operations, doesn’t mean that could translate to something akin to FedEx’s massive network for deliveries, Mr. Smith said. “The key driver of any delivery system is route density and revenue per delivery stop,” he said.
Mr. Smith said Amazon is an important customer and that they expect to continue to do business with them for a long time. Last week Amazon said it agreed to lease as many as 20 planes from an air-cargo company for transporting merchandise around the U.S., something FedEx said it expected.
No single customer, including Amazon, makes up more than 3% of FedEx’s total revenue.
Amazon declined to comment.
E-commerce’s impact was reflected in FedEx’s quarterly results. Revenue in FedEx’s ground segment jumped 30% to $4.41 billion, but higher costs—driven in part by network expansion and peak holiday season demand—caused the segment’s operating income to slip to $557 million from $559 million.
Last year, FedEx launched a nearly $5 billion bid to acquire TNT Express TNTEY 2.15 % NV in part to help it build its e-commerce capabilities in Europe, and bought U.S.-based Genco which specializes in online-shopping returns.
Much of the expansion so far has been funded with debt. Moody’s Investors Service on Tuesday downgraded FedEx’s long-term debt ratings, saying in a report that FedEx’s reliance on debt to fund share repurchases had been “well in excess of free cash flow since 2013” and it had increased its debt. Moody’s also said it believes there is “significant execution risk” in acquiring TNT and noted that FedEx “has yet to quantify the synergies it expects to realize” or the costs.
Mr. Graf said the downgrade had been expected. He said the company is getting ready to refinance and pay off debt.
“We’re a company with a strong cash flow,” Mr. Graf said in the interview. He said the company won’t do anything to push their ratings lower. “We built a very strong balance sheet so we could leverage it at a time like this,” he added.
Mr. Smith blamed some of the trend in low-cost e-commerce expectations on the U.S. Postal Service, which it and other delivery companies, including UPS and Amazon, use to deliver packages the most expensive leg of the trip—to resident’s doors.
“The postal service’s rates, which are the primary driver of e-commerce…they’re going to have to go up as mail service goes down,” Mr. Smith said.
The U.S. Postal Service didn’t immediately have comment.
FedEx’s quarterly results surpassed Wall Street expectations. The company reported earnings, on an adjusted basis, of $2.51 a share and revenue of $12.7 billion.
In comparison, analysts surveyed by Thomson Reuters expected profits of $2.35 a share and revenue of $12.4 billion.
A bright spot for the company was continued improving margins at Express, which contributes about half of total revenue.
The company’s restructuring of the division, which included buyouts and modernization of its air fleet, helped boost the segment’s operating income by 51% to $595 million.
FedEx also lifted the low-end of its earnings forecast for the current business year and said it expects momentum to carry beyond that.
For the year ending in May, the company said it now expects to earn between $10.70 and $10.90 a share on an adjusted basis, up from its earlier guidance of $10.40 to $10.90. Analysts had been looking for $10.56 in earnings per share.