Amazon.com (NASDAQ: AMZN) is expanding its fleet of cargo planes to 50, potentially taking billions of dollars in business from FedEx (NYSE: FDX) and UPS (NYSE: UPS), as it assumes more responsibility for its own deliveries. It also positions Amazon as a future carrier rival.
Because analysts estimate the online retailer accounts for about 3% to 5% of FedEx's revenue and percentages in the low teens for UPS -- though last year the carrier said no customer represented more than 10% -- it's clear UPS has more to lose than FedEx, though losing a significant customer is never good.
While Amazon might not be looking to replace FedEx or UPS, or even the U.S. Postal Service for that matter, but rather to supplement them, it still means they're going to feel the hit.
Image source: Amazon.com.
Amazon, the straw that stirs the e-commerce drink
Amazon is already responsible for about half of all e-commerce conducted in the U.S. and analysts forecast U.S. online sales will exceed $1 trillion by 2025. The USPS is seen as bearing most of the burden for Amazon's sales, handling 62% of its package shipments, followed by 21% by UPS and 8% by FedEx. Another 9% is delivered by regional carriers. But as delivery rates rise across the board, the cost to Amazon is not insignificant and it makes sense it will want to internalize more of the delivery process.
Morgan Stanley estimates Amazon saves $2 to $4 per package when it uses its own fleet, or some $2 billion annually. That's about 10% of what Amazon spent on shipping in 2017. The USPS raised its rates last October, a move that will cost the e-tailer $1 billion in 2019, and that's on the basis of the postal service handling just 40% to 50% of Amazon's deliveries. With FedEx and UPS both raising their rates by an average of 4.9%, the costs to Amazon will be substantial.
Since Amazon has become the hub around which the spokes of e-commerce are arrayed, it needs to lessen the impact the carriers impose on its business. Expanding its air fleet serves as a pressure release valve, helping to contain rising costs, but also relieving the capacity constraints FedEx, UPS, and USPS feel as Amazon grows.
Yet it also puts it in the position to create a rival carrier service to challenge the carriers.
Expansion is in the air
Amazon is building out its fleet of planes, agreeing to lease an additional 10 aircraft from Air Transport Services Group for its Amazon Air service, bringing the total to 50. At full capacity, the hub could handle 100 planes.
Although Amazon says the increase is ostensibly so it can "ensure we have the capacity to quickly and efficiently deliver packages to customers for years to come," it also could enable it to handle third-party packages.
Last year the e-commerce giant began trialing a service in Los Angeles for third-party merchants selling on its website called Shipping with Amazon. It's easy to see how that could transform into a national program, as Amazon is opening an expanded regional air hub at Fort Worth Alliance Airport next year; another hub at the Cincinnati/Northern Kentucky International Airport, which will open in 2021; and a new sorting facility in Ohio's Wilmington Air Park.
Amazon also ordered 20,000 Sprinter vans from Mercedes-Benz in September, a quadrupling of its first order, which will be leased to third-party delivery companies for last-mile package delivery. It's Amazon Flex program lets drivers use their own cars to make deliveries.
Leading the way out
Morgan Stanley sees FedEx and UPS losing a combined 10% of their revenue by 2025 as all of Amazon's air fleet gets airborne, though it's obviously tilted more heavily against UPS. Yet the impact could become even great if third-party retailers also want an alternative.
That's a real possibility because the services FedEx and UPS use for last-mile delivery in partnership with the USPS, which many merchants turn to for offering free shipping as a means of competing with Amazon, are seeing rates rise by 9% on average, and as much as 30% for rural and remote areas.
It would be the height of irony if merchants left FedEx and UPS for Amazon so that they could better compete against Amazon, yet a survey found as many as 55% of online retailers would be willing to do just that if the Shipping with Amazon service became widely available.
Key investment takeaway
Right now Amazon still needs FedEx, UPS, and the USPS to make its commitment to its Prime customers for free, two-day delivery, but Morgan Stanley further notes U.S. express air delivery accounts for 17% of revenues at UPS and 19% at FedEx, so if Amazon is siphoning away last-mile deliveries for itself and others and also taking on domestic air shipments, the impact on the two dominant carriers will be quite large.
Although FedEx and UPS won't wither away and die, Amazon Air will be a larger, more focused competitor than the airlines that currently also compete in the space have represented. Its presence could take some of the pressure off the carriers, but it will also limit their potential to grow their services and revenues at the pace they have.
With FedEx shares down 37% and UPS off 25% over the past year it seems the market has priced a lot of the risk into their stock already. A case can be made their valuations actually assume Amazon pulls all of its business from them, which is not realistic.
So even if FedEx and UPS lose money as Amazon grows, their shares may just represent a good value when it's realized the worst-case scenario that's been priced in doesn't come to pass.
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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Rich Duprey has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Amazon and FedEx. The Motley Fool has a disclosure policy.