UPS will replace FedEx as the dominant provider of domestic air cargo for the U.S. Postal Service for the first time in more than 20 years. The express delivery giant on Monday announced that the Postal Service has awarded it a “significant” contract to move the majority of the mail agency’s air cargo in the United States.
The contract will take effect on Sept. 30 and calls for a 5.5-year minimum base term, according to the Postal Service. FedEx’s (NYSE: FDX) contract with the U.S. Postal Service expires Sept. 29.
“Together UPS and USPS have developed an innovative solution that is mutually beneficial and complements our unique, reliable and efficient integrated network,” said UPS CEO Carol Tomé in a statement.
The Postal Service is one of FedEx’s largest customers, but it was clear the relationship would change this year. The Postal Service has been shifting more air parcels to its ground network since 2021 as part of a productivity drive. The agency’s transportation strategy intends to reduce overall transportation costs by $3 billion over the next two years, including $1 billion in airfreight costs savings already achieved.
Lower postal volumes have left FedEx with excess fixed infrastructure for its daytime air network and higher operating costs per unit. FedEx officials have said the contract with the Postal Service was barely breaking even and that they were prepared not to renew the contract if better terms couldn’t be arranged.
FedEx’s revenue from its Postal Service contract in the fiscal year ending Sept. 30, 2022, fell $236 million to $1.9 billion and was expected to continue decreasing. The contract previously generated annual revenue of at least $2 billion.
How UPS will be better able to turn a profit is unclear. The company declined to provide further details.
But it’s likely the new deal involves a streamlined daytime network that focuses more on truck routes and smaller aircraft, and doesn’t commit as many aircraft to dedicated Postal flying, something that FedEx officials said they were trying to achieve in negotiations.
During FedEx’s third-quarter earnings call on March 21, Chief Customer Officer Brie Carere said the sides were making progress on an agreement that would provide service to fewer markets and allow FedEx to adjust the service to demand. FedEx is in the midst of restructuring its own air and ground networks and said it needed any Postal work to fit within its new, more efficient structure.
“FedEx and the United States Postal Service have had a long and productive relationship for more than 20 years. Over time, our respective strategies have shifted as we transform our networks and operations for the future,” FedEx said in a statement. “We have long said we would extend the contract with the USPS if we could agree to commercial terms in the best interests of FedEx shareholders. Although we were unable to reach mutually agreeable terms, we remain committed to delivering outstanding service through the completion of our contract in September.
“Upon the conclusion of the contract, we will implement adjustments to our network that will drive efficiencies and create more flexibility. The elimination of structural costs currently in place to support postal service volume will be addressed and, in conjunction with our DRIVE efforts, FedEx profitability will improve in FY25 and beyond.”
DRIVE is the name of FedEx’s cost-reduction initiative.
Equity analysts have argued that FedEx’s airline was much bigger than necessary, in part because of commitments to fly postal shipments during the daytime in addition to its overnight express operation. UPS operates a smaller daytime network and only flies shipments when ground transportation can’t meet two-or-three day delivery commitments.
FedEx devotes about 100 aircraft to carry postal business at an annual cost of about $3 billion, according to an earlier analysis by Brandon Oglenski, senior transportation and logistics analyst at Barclays Bank. In its December earnings report, the company identified the Postal Service contract as a $400 million drag on earnings. The Priority Mail packages that FedEx primarily hauls have a similar service (two to three days) and pricing profile to packages moved by ground transport, which translates to lower yields and margins when using air transport. Oglenski estimated FedEx could cut 50% of its daytime network capacity if it doesn’t renew the postal contract, which could save the company $1.5 billion.
Still, the Postal Service breakup could represent a loss of 1% to 1.5% of FedEx revenue, Morgan Stanley analyst Ravi Shankar said in a client note. Analysts were uncertain about how quickly can FedEx can further shed structural costs associated with the postal business and improve profit margins.
“Finalizing this agreement is a key step toward achieving our operational and financial sustainability goals,” the U.S. Postal Service said in a statement.
UPS investors don’t appear enamored with the Postal Service contract. Shares are down 1.2% during early trading on Monday.
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