(Bloomberg) -- FedEx Corp.’s shares tumbled after an earnings report that exposed weakness at the company’s express air business, raising questions on whether deep cost cuts are enough to boost the profit potential of a unit that requires heavy spending to purchase, maintain and fly aircraft. 

FedEx Express, the company’s largest unit by sales, is still struggling from weak freight demand and overcapacity as commercial airliners that also carry cargo resume international flights. The business was also hurt by customers who opted to send packages by a slower, less expensive mode of transport, including the US Postal Service. 

FedEx, founded by Fred Smith in the 1970s on the novelty of express air service, quickly grew alongside global trade and just-in-time inventories that required a quick mode of transportation. Now, after supply-chain disruptions, a war in Europe and trade tensions with China, companies are rethinking those lean practices and their global strategies. 

“At some point you have to ask the question, do I really need to get my package there first thing in the morning? Can it get there in the afternoon?” said Helane Becker, an analyst with TD Cowen, in a Bloomberg TV interview. “To the extent the answer is yes, you see people trading down from express to ground. And that’s the future.”

Shares fell more than 12% in early trading in New York to $246.05, the most since Sept. 16, 2022.

Operating margins at the Express unit sank to 1.3% from 3.1% a year earlier. During the height of the pandemic and supply-chain disruption in the second quarter of 2021, margins had reached 8.7%. FedEx said that it expects margins to be slightly lower than last year’s 2.5%, while margins will gain at its more profitable Ground and Freight units. 

FedEx Chief Executive Officer Raj Subramaniam began a restructuring of Express, including potentially merging its delivery network with the Ground unit, soon after taking over from Smith as CEO in June 2022. The company expects to save as much as $6 billion under Subramaniam’s plan. It’s unclear now if the problems at Express will dissipate when freight demand rebounds. 

“While we appreciate the “profound” changes mgmt. is making, the reality is that a turnaround in Express has been years on-the-come,” said Patrick Tyler Brown, an analyst with Raymond James, in a note. “We do remain somewhat concerned that truly turning the Express segment may be structurally impaired.”

With the weakness at Express, FedEx reported adjusted earnings of $3.99 a share, the Memphis, Tennessee-based company said in a statement. Analysts had expected $4.19. Sales fell 2.6% to $22.2 billion. Analysts had predicted $22.4 billion. 

“The miss was driven solely by Express,” said Christian Wetherbee, an analyst with Citigroup in a note. “Ground and Freight profit both beat.”

This year’s peak shipping season has been muted as consumers return to stores and contend with inflation and higher interest rates, denting buying power. Nonetheless, FedEx’s Ground unit posted gains on volume and price per package, helped by customers who made the switch from United Parcel Service Inc.

The soft market enabled FedEx to improve its on-time delivery performance, which may make it more difficult for UPS to win back lost customers, Garrett Holland, an analyst with Robert W. Baird & Co. wrote in a note. Both UPS and FedEx delivered about 98% of packages on time in the week after Thanksgiving, according to ShipMatrix, a consultancy that gathers industry data.  

FedEx’s adjusted operating margin rose to 6.4% from 5.3% a year earlier, spurred by permanent cost reductions that are expected to reach $1.8 billion for the fiscal year, FedEx said.  

The company lowered its sales forecast to a “low-single-digit percentage decline” from an earlier forecast of little changed. The company left unchanged its forecast of adjusted profit of $17 to $18.50 a share.

Ground units sales rose 2.9% to $8.6 billion and operating margins rose to 10.4% from 7.1% a year earlier on higher volume and revenue per package, showing that the courier still has pricing power even as the market cools from the pandemic highs. Cost per package declined 2%, FedEx said. 

The Express unit’s sales fell 5.6% on lower volume and a shift toward lower-yielding services. 

FedEx’s freight unit, one of the largest US trucking companies, saw sales drop 3.8% because of the drop in cargo demand. That weakness was offset a bit by cargo that carriers picked up from Yellow Corp., which ceased operations earlier this year. Operating margins for the unit rose to 21% from 18%. 

Subramaniam’s cost reductions have underpinned a 62% gain in FedEx’s stock price this year through Tuesday’s close. On a conference call with analysts Tuesday, he announced a restructuring of the Express unit by dividing up uses of its aircraft into three categories that it designated as purple, orange and white. While the Express unit is taking market share from competitors now, the industry is declining, which has put pressure on margins, he said. 

“I’m very confident the margins at Express will return and the cost take-out that’s continuing to take place will serve us very well especially as the demand profile returns,” Subramaniam said. 

--With assistance from Tom Keene, Lisa Abramowicz and Jonathan Ferro.

(Updates throughout.)

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