You'd expect the rising price of oil to hurt shippers like
, which have massive fleets of planes and vehicles deployed around the globe. But it is not. Even as oil sits at historically high levels, FedEx says business is better than ever, and UPS continues to pay hefty dividends to shareholders.
There are various reasons why high energy prices haven't hurt the shippers. First and foremost, surprisingly enough, fuel costs are a minor part of the massive shipping business, far less than what is spent on wages and infrastructure. Also, unlike other industries, shippers pass along the rising costs to customers without sapping demand, and ultimately, companies have found innovative ways to ensure that vehicles sip instead of slurp fuel.
In FedEx's fiscal 2004, which just ended in June, the company spent nearly $1.5 billion on fuel, about the same amount as
in its last fiscal year. At Northwest, fuel is the second-largest expense, accounting for nearly 16% of its total costs, but at FedEx, whose revenue is more than double Northwest's, fuel is the sixth-largest expense, just 6.4% of total costs.
The staggering size of FedEx's operation means that the 10% jump in fuel costs seen in fiscal 2004 is a drop in a very large bucket that is far more sensitive to the overall economic outlook than one variable like oil. Citing the economy's strength, FedEx surprised some Wall Street hands on Monday by boosting earnings guidance for fiscal 2005 and its upcoming quarter, the results of which will be released on Sept. 22.
"We have strong momentum in our businesses and believe the economy continues on a sustainable expansion path," said Alan Graf, company CFO. "While there are potential risks on the horizon, such as prolonged oil costs that could impact the worldwide economy, we believe we will continue to see strong demand, which will result in higher earnings."
Indeed, the biggest risk FedEx faces with oil is a secondary one -- that oil will cause shipping demand to suddenly downshift. This isn't to say that rising oil can't and won't affect FedEx's business. Last week, Morgan Stanley analyst James Valentine grew so concerned over the issue, he lowered his estimates on both FedEx and UPS, warning investors that oil could weaken near-term results.
Passing the Fuel Buck
But Valentine stressed that oil is not a major concern because FedEx and UPS have instituted fuel surcharges, unlike the airline industry, whose chronic attempts to add $5 to the price of a one-way ticket over the last two years have been largely unsuccessful.
"UPS and FedEx are largely unaffected from variations in fuel prices over the long term," said Valentine. "Although our estimates are decreasing in the near term, we forecast both carriers' fuel surcharges to ... help offset the near-term increase in fuel expense." (Morgan Stanley does and seeks to do business with the companies covered in research reports.)
Oil has a short-term impact on earnings because of how the surcharges work. Both companies take the average price of jet fuel over the previous two months and then, once a month, used that to establish a new fuel surcharge, ensuring that costs are covered and consumers are not being gouged.
FedEx and UPS use the previous two months' data on fuel to establish the current surcharge, which is only charged to air shipments and is expressed as a percentage and then added on like tax. Because of this, however, there's a bit of a disconnect when fuel prices spike, as has been the case in July and August.
But as the saying goes, it all comes out in the wash. The effect is always temporary, and both eventually pass on the higher costs to customers, who know it's coming.
"There's no secret in how we do the surcharge. It's a very transparent process. Rates are going to jump in September," said Susanna Rosenberg, spokeswoman for UPS. "It's going to be at 8.5% in September, where in August it was at 7% and it was at 7.5% in July. Our customers see the surcharge and can adjust their needs accordingly."
A nearly 9% increase in prices would waylay other industries where demand is far more fickle, but companies have shifted to just-in-time inventory controls that require them to rely on overnight deliveries of key parts. Companies aren't going to ditch the cost savings and efficiencies generated by the just-in-time model just to save some money. If anything, some companies will trade down to less costly ground shipping or pass along rising costs to consumers via higher shipping prices.
"Businesses choose Express for a variety of reasons. Some of them have made that time-definite commitment to customers. Others have an urgent parts program, where they have to get something somewhere fast, or use just-in-time inventory management," said Rosenberg. "They see the value in paying a bit more."
Since April 6, the last time the price of a barrel of oil was below $35, shares of FedEx and UPS have outperformed the overall market and related sectors, such as the airline industry. Despite a nearly 40% increase in oil prices, shares of FedEx are up 4.7% since April, and UPS is up 1%. Meanwhile, the
is down 3.7% and the Dow Jones Airline Index is off 5.6%. As counterintuitive as it may seem, there's safety in the shippers, as long as the economy is holding up.
Thinking Small Reaps Big Savings
Neither UPS nor FedEx has been content simply to merely pass along fuel costs. For years, the rivals have been engaged in a veritable arms race, discovering all kinds of new ways to make their ever-growing fleets more efficient, in an effort to ensure that fuel is a nonissue.
In March, FedEx rolled out the OptiFleet E700, a hybrid delivery truck powered by a diesel and electric engine that can travel 50% farther on a single gallon of fuel, reducing the company's fuel costs by a third. A month ago, the company began testing a hydrogen fuel cell powered delivery truck, which technically uses no fuel, on the streets of Tokyo. While such programs are tiny -- FedEx will only have 18 OptiFleet trucks in service by the end of the year -- they're a good indication of the importance management places on fuel efficiency.
Since these companies have thousands of vehicles in all manner of shapes and sizes and hundreds of planes, even the most miniscule efforts to cut waste have an outsized effect.
Thinking small has enabled UPS to reap huge cost savings, especially in its preventative maintenance programs. Every single vehicle in UPS' fleet is tracked and monitored to optimize performance. Tire pressures are kept constant, drivers are trained to maintain constant speeds when driving and told not to leave cars idling. A recent change in the way oil changes are performed reduced UPS' motor oil needs by 330,000 quarts a year, saving the company $3 million annually.
"It's even as simple as the day-in, day-out dialogue between drivers and the auto team at the package centers, so if they feel something is different, something has changed in performance, we can adjust it," said Rosenberg. "We don't let problems remain if they cost us extra fuel."