Does FedEx Have a Hidden Weakness?

The freight and air delivery company posted strong 2Q revenue while reaffirming guidance. But is something dangerous brewing beneath surface?

Based on numbers alone, FedEx (NYSE: FDX) is on a roll this morning. The company reported earnings of $1.57 per diluted share for the second quarter (which ended on November 30, 2011). That's a huge increase over last year's Q2 earnings, which were $1.16 per diluted share. But that figure excludes a one-time charge relating to the company's FedEx Freight and FedEx National LTL operations, along with a reserve associated with a legal matter at FedEx Express. With those charges taken into account, FedEx said that last year's Q2 earnings were $0.89 per diluted share.

FedEx's chairman, president and CEO, Frederick W. Smith, provided an encouraging statement within today's company release: “Our improved performance was largely a result of effective yield management programs and strong demand for FedEx Home Delivery and FedEx SmartPost services. With the healthy growth in online shopping this holiday season, demand is increasing for these residential delivery services.”

The company then goes on to promote its deal with Boeing (NYSE: BA) to acquire 27 new 767-300F aircraft. Three will arrive in fiscal 2014, and six per year in fiscal 2015-2018.

“The 767s were selected as the best choice to begin replacing FedEx Express's MD10 aircraft, some of which are more than 40 years old,” FedEx stated in its company release. “The 767s will provide similar capacity as the MD10s, with improved reliability, an approximate 30% increase in fuel efficiency and a minimum of a 20% reduction in unit operating costs.”

Thus far, this is all good news. But there is one tidbit within today's announcement that is, if nothing else, troubling. The company has decided to delay the delivery of 11 777F aircraft for FedEx Express. Two of the aircraft will be deferred from 2013, five from fiscal 2014, and one per year in fiscal 2015-2018, to – as FedEx puts it – “better balance air network capacity to demand.”

“FedEx Express took action during the quarter to adjust its network, particularly in Asia, as recent inventory destocking trends have impacted demand for our FedEx Express services,” Alan B. Graf, Jr., FedEx Corp.'s executive VP and CFO, said in today's company release. “The deferral of our 777 aircraft deliveries is a continuation of those efforts, enabling us to make appropriately-timed international 777 capacity additions over the next decade. With these actions, we expect fiscal 2013 capital expenditures to moderate to approximately $3.8 billion.”

Note that “impacted” is a nice way of saying that the company's demand has been reduced. This wouldn't be a problem if FedEx was able to pick up the slack in other areas. But if that were the case, wouldn't the company be bragging about that as well?

This is something that is particularly bothersome about earnings releases. Corporations will provide the details that are required by law, and throw in a few quotes to round out the story. But rarely do they dig deeper and provide concrete facts about the successes or failures of the firm. They'll occasionally use a conference call to fill in some of the blanks, but even then investors will be left with holes in the story.

If FedEx is ordering new planes while delaying others, there is almost certainly a problem, especially when it involves FedEx Express. Without Express, what advantage does the company have over its leading competitor, UPS (NYSE: UPS)? In the consumer goods market, UPS is the easy winner with more websites using its services. FedEx is a powerful force in business, thanks to its reliability (I've never received a damaged item from FedEx – the same cannot be said for UPS), varying shipping options, and overnight speed.

Wondering if price was a factor in either company's success, I used the shipping calculators on FedEx.com and UPS.com to see how much it would cost to send a five-pound package from Southfield, MI to Beverly Hills, CA. Across a long line of shipping options (ranging from overnight to four-day delivery), FedEx and UPS rates were almost always within a dollar of each other.

But UPS does have an advantage in terms of availability (there are more locations), brand reach (more online retailers use UPS than FedEx), brand promotions (UPS commercials air far more frequently than FedEx ads), and consumer perception (when you think of a really large shipment, what do you envision? Brown UPS boxes, most likely – not the fancy white packages that FedEx uses).

FedEx is by no means a doomed company. But while the rise in FQ2 profit and reaffirmed guidance sound great on paper, that doesn't mean FedEx will sail smoothly from here on out.

Follow me @LouisBedigian

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