FedEx Risks Losing $1 Billion USPS Contract To UPS

Logistics services company FedEx (NYSE:FDX) stands the risk of losing business worth more than $1 billion a year with its largest customer, the U.S. Postal Service, to its larger rival United Parcel Service (NYSE:UPS). The struggling U.S. Postal Service recently decided to seek fresh competitive bids for the contract that expires in September 2013. FedEx held the contract from 2000 and renewed it till 2013 in 2006, but it will now have to compete with UPS, which is also keen on bidding for the contract.

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Impact on FedEx

FedEx earned around $1.4 billion from USPS’s contracts in fiscal 2012, while UPS just earned $100 million during the same period. UPS is very keen to bid for FedEx’s USPS contract, which includes priority and express mail as well as domestic air transportation for first class. This means that either FedEx will lose the contract or be forced to negotiate less favorable terms with the Postal Service which is cash-strapped and is undergoing restructuring after recent losses.

The contract loss would cost FedEx just 3% of its sales, but might be temporarily disruptive. If FedEx manages to win this contract back, it will most likely be on less favorable terms. That is likely to have a negative impact on FedEx’s capacity utilization and profitability. But losing the contract to rival UPS would give a significant boost to the latter’s earnings, and FedEx will try its best to retain the contract.

Though Timing Gives Room for Appropriate Capacity Adjustment

Anticipating moderate demand and due to continued diversion of business toward lower-priced and slower delivery options, FedEx recently announced cost-cutting and restructuring plans to better align its network capacity with expected demand to improve network utilization efficiency and profitability. It converted its previous order of four Boeing 777s with 19 smaller Boeing 767s for greater fleet flexibility and fuel-efficiency. It also delayed the delivery of 11 Boeing 777 freighter planes to keep expenses low until demand improves, and will retire 18 Airbus A310-200 and 6 Boeing MD10-10 aircraft and related engines permanently from service to slim down its express network.

The timing of the USPS contract expiration a year after FedEx’s current capacity readjustment gives the company sufficient visibility and time to adjust its network accordingly. For example, if the USPS contract is not renewed, FedEx will remove about 5,000 drop boxes at U.S. Postal Service locations in about 340 metropolitan areas. The company is expected to provide more details about its restructuring plans for its Express division at its October analyst meeting.

We have a $106 Trefis price estimate for FedEx, which is around 15% above the current market price.

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