FedEx Corporation (NYSE:FDX) Bernstein's 40th Annual Strategic Decisions Conference May 29, 2024 1:30 PM ET
Company Participants
Jeni Hollander - IR
Raj Subramaniam - President, CEO, and Director
Conference Call Participants
David Vernon - Bernstein
David Vernon
All right. Good afternoon, everyone. Welcome to the first afternoon session. My name is David Vernon, I cover transports and airlines at Bernstein. We are thrilled to have for the first time in my 10 or 15 years covering the company, FedEx is joining us at the SDC. We are in their quiet period. So they have a little bit of restrictions on some of the stuff they can talk about. We are going to get into some Q&A. I think what we're going to do here just so you guys know that you probably know the drill by now. We do have a digital app. If you have questions, put them in there, and I can try to work them in through the iPad. If there are and then -- what we're going to do is have Jeni Hollander from IR come up and read a couple of forward-looking disclosures. And then Raj is going to kick us off with some prepared remarks, and then we'll get into the Q&A. So thanks again for attending the conference. Thanks to FedEx for attending, and I hand over to Jeni.
Jeni Hollander
Thanks, David. Certain statements made today such as projections regarding future performance, may be considered forward-looking statements. Such forward-looking statements are subject to risks, uncertainties and other factors, which could cause actual results to differ materially from those expressed or implied by such forward-looking statements. For additional information on these factors, please refer to our press releases and the filings with the SEC.
David Vernon
All right. With that, I think we'll let Raj kick us off with some prepared remarks.
Raj Subramaniam
Well, thank you, David, and thank you all. This is my first time to be at this conference and look forward to sharing some comments about FedEx, who we are, how we are transforming and where we are headed, and then we'll take questions after that. So firstly, I just want to talk to you all about the critical role of FedEx place in expanding global trade and to help build smarter supply chains and delivering products and services to customers around the world.
I thought I'll start by giving you a few stats that illustrate the scale of our operation. We link more than 99% of the world's GDP. We delivered more than 15 million packages every single day. We reach over 220 countries and territories, including every single address in the US. We operate more than 5,000 facilities, 700 aircraft and more than 200,000 vehicles more than -- have more than 500,000 employees worldwide and generate 1 petabyte of data every single day. Now of course, we didn't achieve all this overnight. And over the course of 51 years is what has taken us to get here. Our service offering started with just 186 deliveries back in 1973, beginning with our Express, our time-definite business, which is now the world's largest air cargo airline. We expanded into the ground or day-definite parcel business in the late '90s with our acquisition of Caliber Systems, which has now become FedEx Ground. And following the acquisition of American Freightways in 2001, we rounded out our offering establishing FedEx Freight, which is now the country's largest less than truckload or LTL carrier. Now as we have grown these businesses over time, our customers have embraced the bundled offering with nearly 80% of our US revenue now coming from customers using Express, Ground and Freight services.
The first point I want to really make now is that building networks is a hard and time-consuming work. And it’s thanks to these networks, we can pick up a package or a pallet anywhere in the world and get it to any other part of the world in a very short time. People use the word networks all the time, but sometimes they don't really get it. When you use the telephone, you understand what a network is, you can pick a phone and call anyone. Similarly, when you have a global network, you pick it up from anywhere and deliver anywhere else. And that is an enormous moat that we have around us, that’d be almost impossible to replicate. If you try getting a square foot of space in either Paris airport or Shanghai or in Delhi or wherever, you know what I'm talking about. And with the unmatched global logistics networks, outstanding customer service and an iconic culture, driven by our people, we have built deep relationships with our customers, and we are extremely proud of the work we do. For example, we continue to deliver vaccines and critical health care equipment as we did throughout the pandemic. We transport key manufacturing inputs to keep the supply chains moving, or even ensuring that the Lombardi Trophy makes it to Super Bowl on time.
Since the turn of the century, we have grown our revenue at roughly 6% compound annual growth rate. This is true even including the demand volatility we saw during and after the pandemic. With our resilient networks, we manage this unprecedented COVID demand surge when our revenue grew at a roughly 15% compound annual rate for two years. And more recently, we have navigated the retraction in demand experienced across our industry. The market has evolved, and we are evolving our business with it. We saw this downturn come early, and embarked on a structural cost reduction program, and we are ensuring that we are well positioned to improve profitability irrespective of the demand environment. And we are ready to emerge as an even stronger company when demand inflects positively and we return to that normalized growth rate. And through these efforts, we are significantly improving the profitability of the company as we lower our cost to serve, enhance capital efficiency and better serve our customers with market-leading capabilities.
We are in the early innings of our cost reduction efforts, but progress is already evident in our results. This includes margin expansion and earnings improvement over the past three consecutive quarters despite the declining revenue environment. The entire industry is feeling the revenue pressure, but we are unique in our ability to grow profit even in these market conditions. And this is a clear sign that our efforts are working. Our target is a combined $4 billion in cost reductions in fiscal year '24. By the way, our fiscal year '24 ends on Friday. And combine fiscal '24 and '25, which begins on Saturday. We are examining every aspect of our cost structure with a focus on our surface network, our air and international network and G&A. We shared at our Q3 results that we expect to deliver $1.8 billion in savings this fiscal year and another $2.2 billion in fiscal '25.
When it comes to CapEx, FedEx is at an important inflection point. Our multiyear aircraft fleet modernization strategy positions us well as one of the youngest fleets in the industry. Our capital expenditure continues to decline as a percentage of revenue as we reduce capacity investment and plan for lower annual aircraft FX. This enables us to focus on returning cash to stockholders through share buybacks and dividends.
Now let's talk about network transformation. And first, let me provide you a little bit of context of how we got here and more importantly, what -- where we're going. For many years, we ran our businesses with a strategy to compete collectively and operate independently, which served us quite well. For example, 25 years ago, we held a 10% share in the ground parcel market, 10% with a 70-point market share gap versus our primary competitor. And thanks to our simpler and faster model paired with a stronger service, we grew market share every quarter for several years, narrowing that gap to about 10 percentage points today, 70 point to 10 points.
So you may ask the question, why change? Well, the most meaningful change in the market is the emergence of e-commerce. A vast majority of growth in the parcel market is now driven by e-commerce. A little less than 10 years ago, roughly 75% of the stocks, or packages stocks were businesses. What that means is we have a FedEx Express truck and a FedEx Ground truck pulling up to a business just like this building perhaps delivering six time definite packages and 10 day-definite packages. At the same stop, and this approach made business sense because the rest of the network was fully optimized for time-definite and day definite services, respectively. You fast forward to today, now about 75% of our stops again, our packages stops are residential. So you might see a FedEx Express truck drop off a package at your house, followed by a FedEx Ground truck sometimes delivering another package later in the day. So now you can imagine the room for improved density and efficiency.
So that brings me to our transformation and how we're changing the way -- we run our business to better align with market demand and operate more efficiently. And this is the reason why in April 2023, just over a year ago, we announced a multiyear strategy to unify our businesses and create the world's most flexible and efficient and intelligent network. And one important pillar of that transformation is what we call Network 2.0. It is the network of the future, where we are combining our Express and Ground networks in US and Canada. And the best way to think of Network 2.0 is one truck, one label. We’ve spent the past several years updating our technology and facilities to prepare, and we are now in the execution phase. We have already implemented Network 2.0 in over 50 locations with dozens more to follow this calendar year. And as we have stated previously, we're targeting a $2 billion in cost savings in FY '27.
Additionally, we are redesigning our global air network. We will improve the efficiency and asset utilization of the entire FedEx system to put the right product and the right network to drive density. Our work here will allow us to use our unique talent distribution capabilities worldwide to profitably target more of the premium airfreight segment. We will do this with a truck fly truck model, leveraging existing capacity in our trucking networks to move the international freight shipments. All our revenue growth initiatives, structural cost reductions and network transformation efforts are managed through a program that we call Drive. Drive is simply the way we work, is characterized by rigor and discipline with a keen focus on business outcomes and very quick decision-making timelines, especially for an organization of our size.
So now that you have a glimpse of the major change underway at FedEx, let me share a few thoughts on our formula for future success. First, we are focused on return to profitable growth. This is growth in higher-margin segments like technology, healthcare and small and medium businesses. Second, we will continue to drive our structural cost improvements, lowering our cost to serve. We have made considerable progress here, but there's more value to unlock. As I shared previously, we expect to achieve $4 billion in savings in fiscal year '25 plus an additional $2 billion from Network 2.0 in FY '27. And third, we leverage the vast amount of data we access from the 15 million packages we deliver each day. We will create data-driven solutions that bring internal efficiencies and enable us to better serve our customers. These solutions really build a platform mindset of reusability and scalability with a mission to make supply chains smarter for everyone. Just think about this. Prior to the pandemic, if I had mentioned the world supply chain, I probably would have been politely escorted out of the room. It was the preview of procurement managers, perhaps the CFO. But ever since the pandemic, supply chains have now risen to Board-level conversations and you will hear even in talk shows these days. So this is the right time for us to make our mission to be -- to now become -- make a pricing smarter for everyone.
We're already obviously a leading supply chain company with an unmatched global physical network. We moved more than $2 trillion worth of goods every year and we sit in the middle of an immensely powerful data ecosystem. Leveraging our physical network and our digital platform, we are on our way to becoming a leading supply chain technology company as well. So these three long-term strategic priorities are interconnected and create even more value when they are all motioned together.
I hope that you will take away from today's conversation my conviction that there's enormous opportunity ahead of FedEx as we transform how we operate while continuing to offer our customers unmatched speed and service. Thank you for your attention here. We look forward to the Q&A. Thank you, David.
Question-and-Answer Session
Q - David Vernon
All right. Thank you very much for the overview, Raj. So I want to kind of structure our discussion in a couple of different areas. First, talking a little bit about some bigger market trends that you might be able to help shed line on for investors. Talk about some of the sector themes that are important and then maybe dig into some of the cost production trends and restructuring that you've got underway. Okay. So starting in the area of sort of big picture themes, you mentioned supply chain being at the forefront of many companies' minds. And it does feel like we're now in a world where there's always a supply chain crisis somewhere. How is FedEx positioned in the marketplace to capitalize on that or uniquely benefit from the increasing volatility that seems to be affecting the global supply chain?
Raj Subramaniam
Yeah. So 100% agree with you that supply chain has now suddenly risen to the top of the list on several people's agendas. And if you go back in history, and especially in the last 35 years that I've been working at FedEx, that the supply chain perturbations have been rather muted, even in like the oil crisis or even in the 2008 financial crisis and so on and so forth. This is because of the physical systems like ours and the improvements in technology. So the perturbations were, of course, there were, but they were minimal. What we are now seeing the pandemic was not -- is one giant change. And so the supply chain will lip effect that we are seeing right now. So from a FedEx perspective, we've -- if you go back like, if you went to sleep in 2020 and wake up today, we grew roughly 6% CAGR in the last four years. And it's comparable to the last 25 years, except the fact that there was a huge spike for two years and then a modest decline in the last year. So I think this is a unique period in the last 35 years. And so that's why you see some there's not multiple things happening. It's part of the same, still reverberating from the historic pandemic issue. So from a FedEx point of view, we get to see the signals early, and we're able to move faster. Our mission to make supply chain smarter for everyone is coming in from this idea that we simply have the data and more involved with the insights about the global supply chain every single day, especially the high-value goods of the economy. So today's supply chain trends is different than tomorrow and the term is changing. And so -- and we are watching it very carefully. We are making sure that we use information to make sure our networks are very efficient, but we're also integrating with our customers to make sure that their supply chains are efficient. And the age of e-commerce make sure that the end consumer gets the value by getting increasing predictability and reliability. So that's how we are doing our physical and digital networks are now working together to make that happen.
David Vernon
Is it fair to say that volatility is actually helping from a revenue growth standpoint in terms of the demand angle? Or is it more episodic?
Raj Subramaniam
The volatility, as we think about the last four years, I mean, that's what we were two years of real steep increase in the demand and then two years of slight decline. I think we are all seeing as an industry now when that bottoms up, then I think we will store gets back into a more normalized environment. But again, if you think back about the e-commerce as a penetrate percentage of retail, spike came back. So a lot of things have really come back to the original trend except for interest rates and inflation, right?
David Vernon
And one of the other sort of supply chain megatrends you talked a lot about, frankly, a lot of ink is built on. Is this issue of near shoring?
Raj Subramaniam
Yes.
David Vernon
And I want to ask a question to you in two ways around nearshoring. Number one, are you seeing those shifts in sourcing? And are they tangible enough to actually impact your business?
Raj Subramaniam
Yes. The supply chain patterns are fundamentally changing, and you can see it, the -- it's not just as people talk about a diversification into new markets. It's not just that. It's like all the intermediate products were built in different countries, they made their way to China, for example, and then went to the final consumption point of US and Europe. That pattern is now changing. And we can see different things are happening in that. So it is not only that new countries are coming into play, just the patterns or all goods are produced change. And the good news for FedEx is that we see it from the bottom up because practitioners on this -- in this business when a manufacturer wants to change any kind of thing in their supply chain, they need to make sure that the logistics is taken care of. So we hear about it first. And so we -- and the good news from FedEx point of view here again is that because of the network that we already have in place, nearly every single time that we already want to move you already there. And it's just a matter of just connecting to that point. Even if it was a new point, as a matter of connecting that point to the nearest node and then boom, that wall is connected. So we're -- we have an inherent advantage in that sense that we already have a network in place. Now to specifically, Mexico is an area where things are moving towards -- you can see it in Vietnam. You can see in Southeast Asia, you can see in India. And we'll see how these trends play out, but we see it, like I said, in the bottom up and we move past the manufacturing.
David Vernon
So if you think about Mexico becoming more important than trying to sort of at the margin, does that pose a unique risk to you guys…
Raj Subramaniam
No, no. Not at all.
David Vernon
…cargo network because you probably don't need to plane.
Raj Subramaniam
No, but we have a fan I just was there in Mexico. Actually, we have a fantastic advantage FedEx in that sense because -- just think about the presence we have in Mexico and the ground-based networks that we have in the United States and you put the two together, we actually have in a very unique situation there because if you look at our competition, they're not that big in Mexico. If you look at DHL, they're not that big in the United States. And so it's -- we are actually in a catwalk seat in that perspective. And we have all the ground-based distribution models that we have in US. So no, I think that's actually -- like I said, it doesn't matter where it moves, you're already there.
David Vernon
But there's a great challenge around the air assets.
Raj Subramaniam
No, we will size our air assets depending upon traffic. I think with today, Asia represents, I don't know, 40% of global manufacturing and I see that go down maybe a little bit, but -- so it's -- we will manage overall capacity based on the demand environment. That's not the problem.
David Vernon
Okay. And then if you want to talk a little bit about some of the sector themes. Obviously, the growth of e-commerce. You talked about the moat and the economy and [indiscernible] something that the -- we think we understand pretty well. But when you're talking to investors, we hear a lot about this idea that, hey, what Amazon just stood up a network with more trucks than FedEx Ground has. How is it -- what [indiscernible] you.
Raj Subramaniam
When you talk about a moat, the business itself is fundamentally different because it's sort and deliver, not just deliver. So if you look at our FedEx facility, packages come in and out, they move through it in minutes. When you look at a comparable e-tailer facility, they're going to stay there for days and weeks. It's a different business. They don't know. And so that's not even a comparable thing. So this idea of a network that's why specific, they said a network. Network is we have to pick up and deliver. And that's what we have uniquely have. And so there is a significant -- the other part is that if you look at a FedEx truck delivering moving the road, there's packages from all over the world and the revenue on that truck is significantly higher than just what you can pick up on local delivery. So there's significant scale advantages that we have. Of course, we had to adapt our network, just the e-commerce growth is which is what we are doing right now, which we are done. No, we are actually very -- we have done a pretty good job of adapting to the changes, but I think with more to come, and the technology also plays a significantly critical role as we move forward. So for e-commerce it’s ultimately a good thing for FedEx.
David Vernon
But do you think it's fair to say that the growth of e-commerce has brought margin pressure for the industry?
Raj Subramaniam
Well, when the [originals get and go] (ph), yes. But if you now look at what we have done with FedEx Ground, and even in the literally in the last three or four years, you can see the margins continue to expand. So it's even with this significant e-commerce. It's just that our network adapted to this new environment. And we are -- people talk about the last mile, but they forget about the first few thousand miles. And there are only very, very few people, very few companies who can deliver.
David Vernon
If you just kind of think about the diagnosis of some of the problems before, obviously we're coping and adapting, but there was some margin pressure there from e-commerce. It looks like in the data.
Raj Subramaniam
If you look at, as I said, there was a period of adapting to this, but I think now we're -- we've moved on from, so these things have changed and we have -- we had to put some specific infrastructure to support the commerce, for example, and that's all in there.
David Vernon
So what about pricing? And the challenges you have around the residential delivery part of the business just being in general less productive than making it.
Raj Subramaniam
No, I think we know I'm really proud of the way that we have managed our revenue management function. And this is something that's differentiated in the market for us. We look at this very, very carefully. And if you look, put your eyes, pick up any quarter than in the last 20 years, pick one, open and compare our yields versus our competition, we'll be better. And it's just, we've done a much, much better job of managing, because the value that we provide for our customers is significant, and we will provide, because of that, we need to balance out the needs of our customers and the shareholders and our employees, and we do that very carefully. And again, we have done a really remarkable job on the revenue management side.
David Vernon
Before we kind of dig deeper into the pricing question, I wanted to follow up on one of the things you mentioned before, some of the investments that you needed to make. What did you need to do to adapt that?
Raj Subramaniam
Yeah, that's a great question. Yeah, so we had to put in what we call regional sort facilities, for example, in FedEx Ground, and so then we were able to post in and out of that facility to do some of the local markets with the demand for e-commerce. That's all in place now.
David Vernon
The regional source meaning like the auto sap facility?
Raj Subramaniam
Well, we own a lot of the apps into these, and what we call RSFs, and we suit them up in during the pandemic. And that was just so it was very well in terms of moving the especially e-commerce because I passed the RSS and into the into the customer's hands.
David Vernon
So basically routing some of that higher volume residential stuff around the commercial. Yes, okay interesting. So if you think about you know again back to that comment of whether the moat has been breached, obviously it does feel like Amazon is controlling its own supply chain with just the delivery component of the inventory space, that's growing faster. How do you think about the rest of that market growth opportunity?
Raj Subramaniam
Yeah, I think very good question. So the point here is that the e-commerce market, I think, I suspect Amazon's about 40% to 50% of the market. Now we are partnered with all the retailers on every 1 of them your partnership with them and we are their transportation logistics arm and their growth of e-commerce. If you look at their growth of e-commerce of some of these big retailers, they're also growing very fast. And we are now linked, it's one of the best relationships we have is we are linked at the data level and the technological level right behind the point of order by the end customer. And we are able to get that information into FedEx's hands 12 hours before we normally got, which is a lifetime of FedEx. But most importantly, we were able to then let our customers know how best to optimize their supply chains, given the latest in weather, traffic conditions, and so on. And we're also able to get the end consumer significantly more visibility. So we are now really strategically hooked up with any of the retailers who enable their e-commerce, which is 60% of the market. And that's also [indiscernible] so that there's a significant balancing act that's happening.
David Vernon
Okay. When you think about the, going back to the revenue management side of the equation, you mentioned you're really proud of the way the team sort of helped to adapt and respond. How has the growth of e-commerce created challenges for you on that pricing front? Because it does seem like there's some perception out there that delivery is free and it's harder to get great in that market and maybe Amazon's having an impact because now they're offering some capacity in some markets.
Raj Subramaniam
No, I think, we're talking about 15 million packages per day that go through a system. And, I think we have -- the value that we provide our retailers is very, very clear. And so we have very productive conversations. I mean, for example, Peak surcharges. And that's basically changed the industry, how we deal with Peak, for example. So I think overall, the idea that there's a significant piece of the market that we're playing in e-commerce is growing and we now have a very efficient system to deliver it. We have a good revenue management philosophy, good pricing mechanisms to deliver value for all our stakeholders. I think we're in a good place here and especially as the industrial market comes back to some kind of equilibrium, I think we'll be in good shape.
David Vernon
Let's kind of dig into that for a second, the industrial part of the economy, because a lot of time investors' focus is surely on e-commerce and the potential disruptive effects and all the whole stories you can read about. The B2B part of the business, it does feel like that growth has been a little bit more subdued at a market level for the last couple of years. What do you think is driving that? What do you think about the outlook maybe looking out for here on the B2B side?
Raj Subramaniam
Yeah, so first of all that's why when we, the goods that we move through our system are the high value goods of the economy. That's why we estimate about, we move about $2 trillion worth of goods if we actually size the value of the goods that we move to the system. So these are things that go through the FedEx, whether it is medical equipment, whether it is high fashion, whether it is electronics and so on and so forth. So what we are now seeing is the tail end of the pandemic whiplash. And that's where the industrial goods -- they're caught up in this bigger supply chain bullish effect that I talked about. But again, like I said, if you actually close your eyes and look for years, we're still going 6% CAGR. It's just that the recent two years been on the down draft. And the great news for FedEx is that we have now uniquely growing operating profit even in a declining demand environment. And so, when this bottoms out and comes back, and I'm not going to sit here with timing right now, that's not good, especially in quite a period, is that there's significant leverage in our business, especially as we have shown our ability uniquely in our industry to generate operating profit growth despite the volume decline.
David Vernon
Okay, so did you think about the network integration? Now you mentioned you're starting to take the time-definite error and the data-definite ground network and put it together into a new solution, right? The driver of this is efficiency gain, capability, the driver of the network.
Raj Subramaniam
I think it's very simply, when we have, as I said in my opening remarks, we have two trucks coming to business delivering multiple packages in significant density and we have optimized the rest of the network for that. But when you're delivering to your house and you order two packages and one is coming from one truck and the other one the other truck, that's where we have to do this restructuring. So the network 2.0 ultimately delivers one package, one truck, one neighborhood, and that's where the efficiency comes from and it requires a lot of work and we have prepared for it. We have technology had to work that somebody haven't worked and so that's they know -- we're excited about the progress we're making so far.
David Vernon
So say it takes a lot of pre-work, but we've announced this a while back. We're now getting to the point where the rubber is going to start meeting.
Raj Subramaniam
It already is, it already is, it already is.
David Vernon
The Express and the Ground overhead structures are going to be collapsed.
Raj Subramaniam
Well, so I'm going to distinguish between the network that is coming together and the organization. So as of June 1st, we're going to an organization construct that's just one organization. So instead of having two or three of everything, we only have one of everything. And so that work has already been done. And we'll go into a new structure starting on Saturday. Then, over the next two or three years, FY ‘27 is when we get through the network integration. But the work is well underway. And we are making progress. We're making very steady progress, keeping in mind that customer experience should get better. That's our mantra here, making sure our customer experience gets better.
David Vernon
So as we're thinking about putting these networks together, is the idea, take all the volumes, stick it in one network, shut down a bunch of buildings, keep the existing assets. How should we think about the capacity implications?
Raj Subramaniam
Well, if you think about it, I think we will be able to bring down the total footprint of our facilities and to be able to serve the same market. Now of course when there's growth, we can go into it as well. So we'll get more efficient in the number of facilities we have, we get more efficient in the utilization of our routes and all the way around and of course the backup.
David Vernon
And that's not going to be like a one-size-fits-all solution different markets are going to have different types of limitation. So it's a little bit of a hybrid…
Raj Subramaniam
It’s going to be hybrid model and we will -- we can do based on data and flows we will determine which model makes sense for any particular market.
David Vernon
Okay, and as you think about that asset rationalization component of that, is that a meaningful source of potential uplift for investors to think about, or is that just a byproduct of?
Raj Subramaniam
Well, I'm not going to break it up today, but we're committed to delivering $2 billion savings over and above the $4 billion of savings in FY ‘25 plus another $2 billion by FY ‘27. That's a sizable chunk of money. So I think we get significantly more efficient that way. So we're in that exact period where all of this is going to happen.
David Vernon
So within those numbers, right, those [indiscernible] numbers, the $2.4 billion?
Raj Subramaniam
This fiscal year, fiscal ‘24 is $1.8 billion. Next fiscal year, $2.2 billion. That's $4 billion in total plus another $2 billion.
David Vernon
So the $2.2 billion, right, as you guys are managing that from our program office level, how should investors think about that dropping to the bottom line? I mean. Obviously changes in the business and changes in the baseline affect the capital.
Raj Subramaniam
Again, I'm not going to talk about FY ‘25 right now. That's this directionally the one though -- you can see what happened here this year in the $1.8 billion. So you can see we've broken it down into how, when it began, let me just make it simple. When I began the fiscal year, I gave you all a simple formula. I said revenue growth 1, 2, 3, between $16.50 to $18.50, what we said. And revenue growth was not 1, 2, 3 at all. In fact, we had, with the revenue decline, yet, we are now, the range is between $17.25 and $18.25 [Later changed by the Company to $17.25 and $18.50]. That's what we want. That's what we want the industry to look for. The only way that we made it happen is because of the execution of our strategic cost reduction initiatives. And that's what has helped us deliver on this bottom line growth despite the revenue being off.
David Vernon
Is it right to think though that if business conditions start to improve, that drop through should be better?
Raj Subramaniam
The business -- the leverage is significant, yes. I mean, I think we know is, I can't tell you exactly when the term's coming, but yes, that's when the jaws of the crocodile.
David Vernon
All right. And then just kind of still sitting on this capacity issue. So obviously coming out of the pandemic, volume spiked, everybody added trucks. Maybe the trucks are maybe we're in an over capacity situation, maybe we're not. What's your view on capacity generally? And more importantly, as you think about charging the revenue management team with certain pricing, are you worried about that or were you worried about your capacity and your net?
Raj Subramaniam
I think we are, I think though we have gone through a period of this demand decline in the last two years. We managed -- we can manage the last two years going forward I think it's easier. And so we are definitely managing our capacity to demand in a very strict way and that's what we have to do. Now we have to have a minimum network in place to connect all these points, but I think the issue that you're talking about would have been a much more important issue 12 months ago or even 18 months ago. I think it starts to actually look forward as the demand starts to -- it will come to growth at some point here [indiscernible].
David Vernon
Okay. So as we talk about some of the pending for air network changes that you're going to be making, your long-running air contract with the USPS has kind of come to an end, or is going to come to an end. Does that create opportunities in excess of the revenue you're going to lose, or does that maybe make it harder for you to do some of the things you want to do in the day network?
Raj Subramaniam
Well, one of the things that we were absolutely clear about at the post office was that we're not going to do a deal that's bad for long-term interests of the shareholders. So I was very clear about that. And so we couldn't get to a place where it would make sense for us to do this. So I'll just leave it at that for today. But the idea is at the end of the day is that when Network 2.0 comes along and as soon as we launch in Network 2.0, we can make our networks significantly more efficient and which will benefit the long-term interests of our shareholders. That's where we are.
David Vernon
Okay. As you think about the -- talking about the air network specifically, the fleet strategy, obviously without that incremental data line, does that change the rate of rationalization maybe some of the aircraft or maybe early return we'd be thinking about that as…
Raj Subramaniam
Well you're going to have to wait for us to talk about this when we are past the quiet period.
David Vernon
All right. I figured I'd take a shot. So, let's talk about portfolio for a second. You have, congratulations, inherited as the second CEO over 50 years in a company, a broad portfolio of transportation business in a market where that seems to reward more singularly focused transportation enterprises. So as you think about the idea of being a portfolio of companies being the right strategy for FedEx, how do you think about that being the right strategy given the market's seeming preference for cleaner pure products?
Raj Subramaniam
Well, we constantly review this as a matter of course, so that's a discipline that we constantly have. But what we now have is a unique set of solutions that cross the board that sets us up very well. As I said in my opening remarks, 80% of our customers, 80% of revenue comes from customers who buy all three pieces of the portfolio. Increasingly now, especially with Network 2.0 and because of our international operations, we are now leveraging all parts of our portfolio to make this much, much more efficient, whole network much more efficient. And so they are now much more integrated than you would call a separate. This whole notion of one here, one there, is all sudden moving to the place where we're able to optimize across the full set of networks. So customer facing and customer portfolio, they're buying as a portfolio from FedEx is differentiated because we now have an offering that our competition does not have. And then secondly, on an operational basis, we are significantly more efficient with the networks now that we have because we can use one to the other. And that's especially now with an example on the international side, we're going to have a truck-flight-truck model which actually opens up a whole premium segment of the international air freight market in a small share today. That is, again, networks are very important here, where we go from end to end without an intermediary. So this is a -- we value the networks that we now have and we're making them more integrated.
David Vernon
But if you think about it from a market value perspective, just to address the issue, because it could run up to me a lot. The market has seemingly fell in love with the LTL sector in recent years. Passe management is yellow, revenue management is disciplined, service levels are improving, and that's resulting in much higher equity valuations.
Raj Subramaniam
Well, we look at this portfolio constantly. We think in the long-term interest of the shareholders to keep the full portfolio. We'll look at it from what we've done. We've done a really, really good job with LTL in the portfolio, 10 years ago, 8 years ago. That was a 6% margin business. Now that business is at around 20% margin. And that's the work that we have done not only on revenue management also our operations and my efficiency for operations and -- but now it's become an integral part of the rest of the company, and increasingly so as we move forward.
David Vernon
So as you did dial into what changed in FedEx, great. How much of that margin improvement is better price discipline versus actual operational improvement?
Raj Subramaniam
Well, I think it's -- I don't know. I can't tell you, but definitely both. Revenue management was one piece of the equation, but the operational efficiency and the work that John Smith and the team have done there, which is fantastic. So, we've done a really remarkable job of managing both the operations and the revenue side.
David Vernon
Okay. But if you think about what that business could be worth as a standalone LTL business, It's probably half the market value?
Raj Subramaniam
I don't know. I mean, that's how we think in the long-term interest of the FedEx shareholder, this is -- we will continue to look at it, but it is a clear part of, especially as we move forward in the network or as we move forward into our international, this becomes a significantly increasing portion of our network strategy, in addition to the fact that the customers buy the portfolio.
David Vernon
Okay. So as you think about another part of the portfolio, I do want to talk about Europe.
Raj Subramaniam
Sure.
David Vernon
The TNT acquisition, 2016?
Raj Subramaniam
Yeah.
David Vernon
It's been a tough road.
Raj Subramaniam
Yes. So, let me talk about Europe, because that's a very important question for us. Europe, just to make sure that everyone's on the same page, Europe has basically four different market segments. One is international express market segment where historically FedEx has had high teens share. No problem. We also have the intra-European Express think airplanes market where we had teen share as well. And then there is a larger intra-European ground market and an intra-country domestic market parcel. These are the bigger market spaces and we didn't have any presence in that. So imagine if you didn't have FedEx ground in the US. So increasingly the conversations with customers were getting more difficult because you're basically asking the customers to parse out the traffic and give us the express, but give the larger ground to the competition. So organically building out that out versus buying an existing company which had a significant presence, especially in the intra-European market. So that's where TNT came in. So we had acquisition, we had a couple of unfortunate incidents where one was a cyber-attack and then the other one was a pandemic. And so we had, environment was not the greatest in the way we integrate, but now that we are moved on from integration to value creation. And we also now have a full portfolio of services that are differentiated in the marketplace, what parcel and pallet-based services that we have. And we have started to gain share again in Europe. So Europe is a significant opportunity for FedEx. It is a high amount of focus for me personally, for all our experts at [indiscernible]. I'm headed there tomorrow. We kick off the new year. And it's a site for FedEx. And I think as you said, we've moved now from integrations into value creation mode. And this is the pieces of stuff that works here.
David Vernon
And as you think about that, that line of sight to get in that business back to an acceptable rate of return?
Raj Subramaniam
Yeah. I know we, as in Drive, we have specifically called out the year-over-year improvement in FY ‘25 and just at the beginning, and we will go on from there. So it's a very, very targeted number, managed very, very carefully every week. And so yeah, we are confident that we can get this to a place where I think there is upside opportunity for FedEx.
David Vernon
Okay. And the Board has now sort of adopted ROIC as…
Raj Subramaniam
Yes, yes, yes.
David Vernon
And measurements. Like, where do you think the potential is that? And then as you think about that growth part of it, right? So what way to return to you then maybe start thinking about growth as a bigger part of the story versus margin improvement?
Raj Subramaniam
Well, I think so there are many aspects of that question. So, let me start to peel back down in here a little bit. So, yes, we have ROIC now as part of the metric of remeasure and competitive teams on, and we already made remarkable progress in this literally in the last two years. And I think one of the things is the fact that the aircraft modernization program is kind of now on the tail end. And 10 years ago versus now, we now have the fleet from the industry. And so the aircraft CapEx is going to come down. And so overall now, when you return to growth and then we have the structural cost reduction, so we have significant amount of operating income that starts to come in with the lower CapEx, suddenly we have an opportunity to really improve ROIC and then of course free cash flow.
David Vernon
And the destination for that free cash flow,sShould investors be thinking that's a capital return story or is that going to be a redeployment story?
Raj Subramaniam
Well at this point, we can -- those conversations we continuously have in the last what was announced in the last literally last two quarters of course we've just been primarily in the form of dividend increases and share buybacks, but we'll look forward as soon as we see an opportunity come up, we'll make those calls.
David Vernon
Okay, and as you now are a year or two-ish in the chair, two years in, all right, congratulations.
Raj Subramaniam
Thank you.
David Vernon
As you think about kind of what you want your legacy to be, obviously taking over from Fred Smith is a challenge. It's hard to outspread Smith, Fred Smith. What do you want to be known for coming out of this and what do you think your key messages to investors around what's going to be different about investing in FedEx from today and maybe it has in the past?
Raj Subramaniam
Well, I'll tell you the first thing with Fred. I mean, it's just to build something from nothing and to build from scratch and to build it into this incredible network of statistics that I just wrote out to you. I mean, that is an incredible feat. I often quote Galileo when I say, I see far because I'm standing on the shoulder of a giant. I mean, it's just plain and simple. And it's just, what FedEx has accomplished in 50 years is starting from scratch and facing a very, very significantly larger and very tough competition. So I think now we have the opportunity to significantly leap forward because of the infrastructure that we have already built. And I think that's -- we have been through two years. I've been -- we have an unusual period of revenue picture for the industry. Historically FedEx has -- our revenues never actually declined. I mean, even any period of decline we had significantly hit the profitability, but we have now fundamentally changed that dynamic that we're improving our operating income in even in a decreasing revenue environment, but that's going to change. So looking forward, I think, firstly and foremost, I'm very, very proud of the FedEx culture. And that's, I got to say that upfront, and then that we will, it's something that is unique to FedEx and idiosyncratic to us and we're very, very proud of that, and that will maintain that culture going forward.
David Vernon
But I think the networks that we now have in place that already establishes gives us a differentiated play in the marketplace. And we will use that to really make supply chains smarter for everyone. Supply chains smarter for FedEx, make sure our operations are as smooth as we possibly can. Supply chains smarter for our customers and supply chains smarter for the end consumer and the e-commerce world. And in this environment, our digital story plays a very important role. We have already built a digital tool for FedEx. And we are integrating very deeply into our customer supply chains, making sure that we are able to provide additional value over and above. So at the end of the day, if we look 5, 10 years from now, I think we will see FedEx as a, establish globally the full portfolio of services that are differentiated in the marketplace to provide deep supply chain solutions for the company, but while maintaining the overall FedEx culture. And as you think about, you know, from an investor standpoint, historically FedEx is maybe viewed as a lot more of a cyclical play, booms and busts. How does that proposition change over the next several years?
Raj Subramaniam
I think from an investor point of view, I think it's a, FedEx is really at an inflection point right now for many reasons. First, The fact that we are able to generate operating income improvement even in the face of demand issues. That sets us up well for going forward. That's first. Second, the capital story that I just talked about, we are in a place where we are again inflecting upwards on our ROIC. We have significant upside opportunities that are unique to FedEx and that's the network 2.0 that is a unique upside opportunity for FedEx. The idea of the Europe performance we have, that's an opportunity for FedEx. Going after the premium LTL market and international LTL market, I coined that term international LTL just to make it, it's the international premium air freight market using our networks that we have. That's an opportunity for FedEx. And then the cherry on top is a digital platform story that we are starting to engage on. So I think there's several things that are unique to FedEx. I think we are just at the inflection point.
David Vernon
Excellent. Well, we're coming up to the end of our time together. I want to thank you for coming out and joining us. Thank you all for participation. Obviously, if there's questions for us, you know where to reach us. And thank you, Jenny, for putting us on the calendar. Thank you very much. I hope this was useful.
