Keith Schoonmaker: At Morningstar, we look for businesses with competitive advantages sufficient to outearn their cost of capital for years to come. FedEx is one such business with economic moats in its Ground and Express segments.
We're here today with director of investor relations Jeff Smith from FedEx to talk about FedEx and recent developments.
Jeff, thanks for joining us.
Jeff Smith: Thanks. It's good to be here.
Schoonmaker: Jeff, I'd like to start by talking about something exciting at FedEx, and that is the growth of the Ground segment. Really fantastic growth over the last few years at very high margins. Could you give us a quick update on Ground, maybe a quick recap, and what you see as the future for Ground?
Smith: Well, our FedEx Ground business is very exciting. It's growing as the growth of e-commerce continues to expand. We're getting certainly our fair share of e-commerce shipments going to people's homes with our Ground business.
The margins in our Ground business today are very strong, upper-teens percent margins. Our growth rates have been upper single-digits from a volume standpoint, and then able to push pricing up on an annual basis, so that we get double-digit revenue growth in that business.
So, we're very excited about our Ground business and think that it will be a growth opportunity for our shareowners for many years to come.
Schoonmaker: Jeff, is the growth in Ground largely at the expense of the other major carrier, or is this organic growth? Is this growth that's being diverted from Express? How would you say this is being grown so well?
Smith: Well, we certainly are gaining market share in the Ground market. So, we are getting some business away from our primary competitor. But the market is growing very rapidly due to the growth of e-commerce. So, we have the ability to grow our business with the growth of e-commerce.
Schoonmaker: Let's talk about the model with Ground. This is not the same model FedEx uses for its Express or its Freight LTL Shipping business. It uses independent contractors. Tell me about the model.
Smith: Yes, it's a different model. So, instead of employees driving our vehicles to make deliveries, we have independent contractors who own their own trucks, and make the deliveries in those trucks, and we pay them basically a fee per shipment that they pick up or deliver. The contract is a little bit more complicated than that, but that's at its core. What that allows is a variable cost network, that allows us to effectively compete with a competitor that is much larger than us today.
Schoonmaker: Now, let's switch gears a little bit and talk about another segment. See if I have my numbers right here, Jeff. The Express segment, the legacy segment we think of ... when a consumer thinks of FedEx, is a little north of 60% of sales, Ground is a little north of 20%, and Freight is about 12%. Freight is an LTL, or less than truckload, business.
At Morningstar, we're looking for these moats. In the LTL segment, we think it's difficult to earn an economic moat, because the product is somewhat undifferentiated. There are so many competitors, unlike Ground or Express where it's a little more rational and pricing power can prevail, in the LTL segment during hard times the LTL carriers can be irrational when it comes to bidding rates down, in order to keep their assets utilized. Tell me about the perpetual advantages FedEx might have in LTL compared to another smaller carrier.
Smith: Well, the beauty of our LTL is that it's one piece of our global transportation bundle of services that we can offer to customers. So unlike most of our LTL competitors, our salespeople are selling package, both domestically and international, as well as LTL shipments, and we can come up with a bundled solution for our customer.
So we have the ability to tap into probably a larger base of customers than most of our smaller LTL competitors, and we continue to take the technologies that we've developed over time in our package businesses, that allow them to be best in class and service, and continue to plow those into our LTL business as well. And it is now best in class from a service standpoint. So, with the industry-leading service and a global sales network to help feed into that service, we think we're differentiated from the market, and [that] will insulate us from the ups and downs of the Freight market.
Schoonmaker: Now Freight has had a busy year in the trailing 12 months, hasn't it? We've seen the recovery of some decent market pricing, with multiple rounds of price increases in this space. We've also seen FedEx integrate historically two disparate operations into one single operation, and we've also seen FedEx begin to use intermodal a little bit for some of its longer haul, turning to the rails, where historically FedEx has not used the rails quite as much as competitors might have used them. Can you give me a quick synopsis on what the current status is at Freight?
Smith: It's been a very active year for us--one where we have seen tremendous increases in our pricing with our customers, that has driven tremendous improvement in our profitability. We have also taken two LTL companies that we had in the past, that had a national and regional service, and combine them into one network that offers a priority and economy service, with one pickup and delivery for customers, and that is providing us both efficiency improvements, as well as a better customer experience.
So, in the last 12 months, we've gone from having a loss on an annual basis in our LTL business to being profitable in our LTL business over the last two quarters. And we certainly think that those profits will continue and will grow and get back to a historical profit margin level that was certainly above 10%
Schoonmaker: Indeed, and that's not trivial, since it's affecting 12% of revenue. Having some margin attached to that is going to be accretive to earnings?
Schoonmaker: Jeff, I think the media must have a rule that mandates the use of the phrase Economic Bellwether, whenever they are describing FedEx or its peers. It seems like there must be some sort of macro that gets hit whenever they type FedEx, it must say Economic Bellwether.
You know, FedEx has its finger on the pulse of the economy, especially with the largest or tied-for-the-largest LTL carrier now, certainly seeing what's happening in industrial production as well, not just in small package, but trucking as well.
Can you give us the latest update on what you think is happening in the economy, and what FedEx's noteworthy economists are thinking is happening in the economy, and what you see maybe in the next couple of years?
Smith: Well, certainly the economy is facing challenges at the moment, but we firmly believe that the economy is growing, and that it will continue to grow next year. Our current outlook for next year is to see the U.S. economy have a GDP growth in the 2% to 5% range*. But industrial production will grow even faster than that, closer to 4% next year, and that's an environment that we can continue to do very well in, because its certainly industrial production that drives a lot of our shipments in our FedEx Express and FedEx Freight unit, and then the continued growth of e-commerce, that I talked about before, will continue to drive the growth of our FedEx Ground unit.
So, we base our outlook from what we see every night and day in our Package systems, the traffic that we see going through those systems, but we also base it on the tens of thousands of conversations that we're having with customers around the globe each week, and those customers are optimistic, cautiously optimistic over the next few months and quarters, and that's the basis of our cautiously optimistic outlook for the economy.
Schoonmaker: Great. Well, Jeff thanks for joining us today.
Schoonmaker: I am Keith Schoonmaker with Morningstar.
* Note: Since publication of this video, Smith contacted Morningstar and told us that he misspoke. FedEx expects GDP growth for the next year in the 2% to 2.5% range.