Keith Schoonmaker: Hello, I'm Keith Schoonmaker, Morningstar's Transportation Analyst. We're here today with FedEx Director of Investor Relations, Jeff Smith, to talk about FedEx and its competitive advantages. At Morningstar, we look for businesses that have competitive advantages sufficient to out earn their cost of capital for years into the future.
FedEx has erected a narrow moat surrounding its business, protecting its profit for years to come by erecting a massive network of trucks, sorting facilities, and planes.
Jeff, I wonder if you would mind giving us a quick overview of FedEx, its Express, Ground and Freight operations, so we sort of get the lay of the land for the company?
Jeff Smith: Well, as you said, Keith, we've spent the last 40 years developing this global transportation network and today we have more than 220 countries around the globe that we serve as with our nearly 300,000 employees and contractors around globe. We have unsurpassed air networks around the globe with hubs in the United States, in Asia and in Europe, and we're really at the point where we can really leverage those networks that we've built out over the last 40 years over the next few years to improve margins and returns for our shareholders.
Our Ground business within the United States is a very profitable business and growing rapidly. We have a trucking business within the United States, a less than truck load business that has recently attained market leadership within the United States. And we're really still on the early stages of effectively bundling our trucking business with our package business for small and medium-sized customers around the United States.
Schoonmaker: Jeff, that trucking business is not a trivial business, that's about 12% of consolidated revenue. Is that right?
Smith: It's about a $4 billion business for us today and we certainly expect the ability to grow that business over the next few years will be strong as the LTL market continues to consolidate.
Schoonmaker: Jeff, to continue looking at the size of the whole company, I guess let's frame it as far as percent of revenue: Express still comprises about 62% of total revenue and Freight is about 12%, there's a small amount from services like the former Kinko's business FedEx Office and the rest is Ground. Does that sound about right?
Smith: Yeah. About $22 billion in revenue for Express business, about $7 billion for Ground business, about $4 billion for our Freight business and then about $2 billion in our Services unit, which is primarily our retail network, FedEx Office.Read Full Transcript
Schoonmaker: Those are revenue, that's a sale number. But if we look at profitability, the Ground business is much more profitable than the other segments. I guess I view that as the key to increasing ROIC in the future as well as the acceleration of the international Express shipments.
Smith: Definitely the margin opportunity that we have will be in our international business where we get on average $54 in revenue per package internationally versus $15 in revenue for our domestic Express shipments. So as the international business continues to grow with the growth of global trade, more and more of those higher-value shipments will drive margin improvement for us.
Then on the trucking business we faced a very tough trucking market over the last few years and that's contracted around 25% and during that time, we were digesting an acquisition that we made prior to the downturn. We've just announced a combination that we're going to do in January that will consolidate those two trucking companies that we own, and that will allow us to vastly improve our profitability in that market over next year.
Schoonmaker: Unlike the other markets in which FedEx generally competes the largest segments of Express and U.S. domestic Ground, that LTL segment is highly fragmented--so many competitors can aggressively bid down rates to get their assets utilized. Whereas I view Express, particularly in the U.S. and Ground networks as being more of a rational duopoly, where some rational pricing can prevail. Do you concur with that assessment?
Smith: Well, certainly. I mean, I think there is a historical opportunity for ourselves and for UPS in the package market in United States to achieve a much higher rate of price increases over the next few years than what we have over say the last 15 years. A lot of that being driven by the fact that DHL left the markets, the U.S. domestic marketplace in 2009. So, as you say, there are now two companies that serve the domestic express and domestic ground markets in the United States and we both have publicly said that we expect to get higher than historical price increases over the next few years.
Schoonmaker: I would like to explore that DHL exit a little bit. I view the exit of DHL from domestic U.S. deliveries as really a testimony to the strength of the competitive advantages that FedEx and UPS both have here in the United States, just the cost of opening and operating a business to compete with your established networks is staggering to the tune of losing what nearly $1 billion per year. No one can sustain that indefinitely. So now that DHL has pulled out of domestic U.S. deliveries, can you comment on the implications of that for FedEx's strength as an international firm?
Smith: Well, the United States is still the world's largest import market and so if you want to be a true global player you have to have a significant presence in this import market and unfortunately for DHL today they do not have that significance presence that they once did. So it is hampering their ability to grow as rapidly as they had in the past in Asia and in Europe with those packages that would connect into United States. So we see an opportunity to gain market share internationally due to the fact their presence in the United States has been lessened.
Schoonmaker: I see. Now, we have touched on this international delivery being so important for future growth and future margin expansion within Express. All parcel carriers comment on their opportunities and their efforts that they are making in China. It's hard to see China from here and to understand what is like on the street and what different – what DHL offers there versus what FedEx offers and how strong are relative claims to having significant operations there. How material is China to FedEx operations in the future and could you give me a summary of where FedEx stands in relation to its competitors in China? Two questions.
Smith: We have been in the China market for a number of years. We were the first of the international carriers that flew our own aircraft into China to deliver goods and pickup goods for the international markets. And that commitment has driven us a very strong positioning and we certainly feel today we have market leadership and exports from China, and revenue exports from China and are growing that leadership. We have – of UPS and DHL we're they only international competitor to have a domestic express option within China.
Schoonmaker: Is it 50 cities that are served up currently?
Smith: Yeah, we have a network that allows customers to have overnight delivery to around 50 or more than 50 cities and than a two to three-day delivery to additional 200 city, and that's guaranteed delivery. So while there are a variety of local competitors, nobody has the service level and the breadth of locations that they can deliver to that we do in the China market.
So I think you will see our international competitors move into that space over the next few years, but we have been in that market now for a few years and expect to achieve profitability in the domestic express market next year. We will have a substantial lead over our competitors when they decide to enter that market and we think it's a significant strategic mark for the long-term. We view the China domestic market today as about a $5 billion business and…
Schoonmaker: Is that the express business?
Smith: The Express domestic market in China and by the end of this decade, we think that that market with its tremendous growth will be about a $26 billion business.
Schoonmaker: On the subject of China and shipments export out of Asia, the company continued to invest throughout the recession. FedEx still spent – made capital expenditures on aircraft – fulfilled its commitments to its aircraft suppliers and continues to purchase more 777 aircraft from Boeing. Now, this is more than just fleet size enhancement, what's so great about the 777s? Why is it so important to understand 777s in FedEx's investment strategy?
Smith: We are very excited about the addition of the 777 to our international air fleet. The plane brings with it obviously additional capacity that we need to meet the high growth rates that we are seeing in our international markets, especially moving freight from Asia to Europe, from Asia to the United States. The plane also gives us a speed advantage over our competitors. Because the plane has the longest range of any large aircraft in the marketplace we can fly it direct today from our operations in Shanghai to our hub for the United States in Memphis without having to refuel the aircraft in Anchorage, Alaska like our older planes and our competitors' planes have to do. So what does that mean for our customers?
Our customers today when they are manufacturing goods in Shanghai, they have two hours later in the day that they can give us our packages and still have them delivered throughout the United States the next morning versus our competitors and all else being equal, a customer is certainly going to choose the later cutoff time as possible to have their freight delivered to their customer the next day.
Schoonmaker: Yeah, I think that is even more material when we think of what kind of parcels those are, these are pharmaceuticals or high-value electronics with very finite shelf lives where two hours or a day earlier is actually a pretty material portion of that product's market life on the shelf?
Smith: Well, especially when they have relatively low global inventory levels period and customers are ordering goods and they are being moved direct from manufacturing direct to final customers' hands with very little inventory shelf space time. So, hours in the day has an important impact.
Schoonmaker: Jeff, well, thanks for stopping by Morningstar today. We appreciate your time.
Smith: Thank you for having me.