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FedEx problems go beyond its split with Amazon

CNN logo CNN 12/18/2019 By Chris Isidore, CNN Business
a truck is parked on the side of a road: FORT LAUDERDALE, FLORIDA - AUGUST 07: A FedEx delivery truck is seen on August 07, 2019 in Fort Lauderdale, Florida. The FedEx company announced today it will stop delivering ground shipments for the Amazon company. (Photo by Joe Raedle/Getty Images)© Joe Raedle/Getty Images FORT LAUDERDALE, FLORIDA - AUGUST 07: A FedEx delivery truck is seen on August 07, 2019 in Fort Lauderdale, Florida. The FedEx company announced today it will stop delivering ground shipments for the Amazon company. (Photo by Joe Raedle/Getty Images)

FedEx and Amazon just went through a very public divorce. But that's not the biggest problem for the iconic delivery company.

The problem for FedEx and other delivery services is that the consumers who are making more online purchases expect to receive their items quicker than ever. And they're generally not willing to pay for it.

The Amazon business that FedEx recently lost was some of the least profitable business the company handles. Because of its free delivery policy for Prime members, Amazon demands very low-priced delivery service from carriers who want to get a piece of its massive and ever-growing volume of shipments.

In fact, Amazon has never accounted for a large enough share of FedEx's revenue to be listed as one of its major customers. And analysts believe Amazon depends far more on other services, including the US Postal Service and UPS.

As it moves away from Amazon, FedEx is ramping up its residential delivery service, adding weekend delivery -- an expensive change to make while losing such a high volume customer. But with the Postal Service now making Sunday deliveries, FedEx had to respond in kind, said Helane Becker, transportation analyst at Cowen.

"When I started following FedEx 30 years ago, it was definitely the disruptor. Now they're being disrupted," she said.

FedEx stopped carrying Amazon shipments as part of its express business in June, and Amazon ended its contract with FedEx Ground in August. FedEx Ground is the company's lower priced service, which delivers to homes and businesses. Earlier this month, Amazon told its third-party sellers to stop using FedEx Ground for their Amazon Prime shipments, saying it was concerned about reliability.

Other analysts aren't sure FedEx's new business model will be a good one. Getting packages delivered to homes is expensive, especially when online shoppers have come to expect the delivery at little or no cost.

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Seven analysts have downgraded their recommendations on FedEx stock in the last three months. Adding to analyst concerns are the steps Amazon has taken in recent years to start its own delivery service, buying vans and contracting with drivers directly to make deliveries, rather than giving packages to FedEx or other carriers.

"The structural headwinds on eCommerce are starting to blow even harder," wrote Morgan Stanley analyst Ravi Shanker, who has a neutral rating on FedEx stock but a cautious view on investments in the sector. "If Amazon does launch a full third-party delivery service, like we expect, then [pricing] and competitive pressures will be even more significant."

FedEx officials insist they will see a turnaround by the spring as the company benefits from investments it made in its seven-day service. But they were brutally honest about the company's most recent results when talking to analysts Tuesday. CFO Alan Graf, described the drop in profits at FedEx as "horrific."

While Graf said FedEx fell short on some of the higher priced, heavier commercial shipments it had been expecting in the quarter, Fred Smith, the company's founder and CEO, said customer response for FedEx's weekend service is even better than expected. It handled 14 million packages just this last weekend. And even with the loss of the Amazon business in August, FedEx Ground revenue was up $173 million, or 3%, compared to a year ago. But Smith admitted they had underestimated the cost of expanding the service.

"Starting up to six- and seven-day network was very expensive for us," he said. "Clearly, we didn't do the greatest job of forecasting our cost."

Becker, who has a buy recommendation on FedEx shares, believes the company can adjust and make a profit on the growing level of online purchases. She said it has responded to these kinds of changes in the past.

"They started as an overnight letter company. But even before there was email, Fred correctly surmised that fax would overtake the overnight letter," she said. "You have to admire the tenacity with which he's continued to stay ahead of the curve."

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