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FedEx Corp. (NYSE:FDX) reported a 12% year-over-year drop in quarterly profits. This is due to hurricane Sandy and the global economic slowdown, which has changed customer's preferences from high margin overnight delivery service to cheaper alternatives. This shift was also evident in FedEx's income by segment. Operating profits at its premier air express unit dropped by 33% to $230 million, while margins have shrunk from 5.2% in 2011 to 3.4%. On the other hand, operating income of its slower ground and freight segment are up by 4% and 90% to $412 million and $76 million, respectively.

In short, the fall in air transport was offset by ground operations. This is a trend I expect to continue in the long term as the era of cheap, abundant energy that facilitated the model is over and therefore air freight volume is likely going to drop, but margins may remain as it will weed out all of the price elastic customers, leaving those whose need far outweighs the shipping cost differential.

FedEx earned $1.39 per share - $438 million - which is in line with its forecast but lower than analysts' expectations of $1.45 per share and far short of the $1.57 per share - $497 million - in the same quarter last year. Overall quarterly revenues rose by 4.7% over 2011 to $11.1 billion.

However, excluding the extraordinary losses resulting from hurricane Sandy, income climbs to $1.50 per share. FedEx also said that as long as "the U.S. does not go off the fiscal cliff and into a recession," the company is going to report flat earnings for this year as compared to last year, in the range of $6.20 to $6.60 per share. In the future, growth is expected to be modest at best due to restructuring measures, which includes buyout incentives for thousands of employees. The buyout is expected to cost up to $600 million severely impacting earnings. The restructuring will also revamp its ground operations and make the express air business more profitable.

In its third quarter, FedEx had already reduced its guidance by 10%. Similarly its rival UPS (UPS) also lowered its forecast from $4.75 - $5.00 per share to $4.50 - $4.70 per share citing similar reasons. As I pointed out earlier, the logistics giants, such as FedEx and DHL, have built up their business around the high margin quick delivery air operations which has now come under pressure from:

  1. The rising cost of fuel.

  2. The fall in average selling prices of goods which has forced their clients to shift to other cheaper and slower options to maintain their profit margins.

UPS dominates the ground operations but FedEx's rising revenues in this area indicate it is eating into UPS's market share. Ground operations are becoming a more important part of FedEx - as I've said out of necessity -- and now contribute about a quarter of the total sales. This is where I feel any growth will come from, especially when one begins to consider the changes coming to production models, which I feel are also going to become more regionally focused.

Meanwhile, holiday shipments are expected to reach a record high due to the explosion in e-commerce. The competition in the U.S market is heating up between UPS and FedEx. While UPS is promoting its year old 'My Choice' service for its 'premium' customers, FedEx is busy reminding people that it is the only firm that delivers on Saturday. Deliveries to residential customers are rising faster than those to corporate customers. And, since the residential business is relatively more labor intensive, the key to success lies in the number of customers per neighborhood. This is the main area where both UPS and FedEx are going to fiercely compete in the coming years with new promotions and offers.

UPS

FedEx

Market Cap

$72.13B

$29.27B

Beta

0.89

1.3

Stock YTD

3.31%

11.59%

P/E

22.4

14.56

EPS

3.38

6.4

Yield

3.00%

0.60%

ROA

8.83%

6.96%

ROE

42.37%

13.19%

Since January, FedEx's stock has been ahead of UPS but both have trailed behind SPDR S&P 500 ETF (NYSEARCA:SPY) which is up 14.96% in the corresponding period. At this point, however, UPS trading at a multiple of 22 looks fully valued. Especially if the Fed blows a new commodity bubble with the latest round of unsterilized QE which will cause energy prices to rise faster than GDP and offset any gains made. The difference between their ground operations will then come down to how much of their fleet has been converted to natural gas, which will be relatively cheap for the foreseeable future. FedEx just began a test of the Westport (NASDAQ:WPRT) Cummins LNG engine for its long hauler tractors, but they are more than a year behind UPS on this front.

Source: FedEx Pushing UPS On The Ground