Tuesday, August 12, 2008

Understanding The Outlook

The first inkling that the Postal Service faced difficult times was reported on this blog a little over a week ago. With the publication of the 3rd quarter 2008 10-Q, the Postal Service confirmed that the decline in volumes has already generated losses this year of 1.3 billion. More importantly the Postal Service provided some details of its outlook for the remainder of FY 2008 and all of FY 2009 that indicates that the Postal Service and the mailing industry face another tough year ahead of them.

Revenue Outlook

The Postal Service's revenue outlook is summed in this sentence: "We (the Postal Service) face a prolonged period of slow growth coupled with the threat of stagflation." The Postal Service's current volume forecast is now based on the assumption that 2008 FY GDP growth will be 2.1% and 2009 FY GDP growth will be 0.5% with a decline in GDP through the first two quarters of FY 2009.

The Postal Service expects that the 4th quarter of FY will see volume declines and revenue performance similar to what was seen in the 3rd Quarter. In that quarter volume declined by 5.5% and revenue declined by 2.4%. If a similar decline occurs in the fourth quarter, 4th quarter 2008 revenue will be $437 million below 2007 levels and volume would be $2.8 billion pieces below last year's levels. Withe these assumptions for the 4th quarter, FY 2008 revenue would total $75.265 billion, only 0.5% more than last year primarily due to the decline in volume.

The Postal Service did not provide a revenue forecast for FY 2009 but they provide some parameters that suggest that they expect that the volume declines that began in earnest in the 3rd quarter of 2008 will continue though at least the first two fiscal quarters of 2009. Furthermore, it is not clear if they see any improvement over current volume levels in the second half of FY 2009 without a robust turn around in the economy. Without completing more serious calculations, assuming that FY 2009 revenue would be no higher than what was generated in FY 2008 would seem a reasonable even if the Postal Service raises rates at the maximum levels permitted under the rate cap.

Expense Outlook

The Postal Service's comments on expenses suggests that making expense reductions neccessary to bring it back to break even will be difficult. While the Postal Service has reduced work hours in FY 2008 by 40 million work hours, increases in wage rates and fuel expenses has resulted in a 0.4% increase in expenses this year. The increase was even higher in the 3rd quarter which experienced a 0.94% increase in expenses. The Postal Service notes that COLA adjustments will raise 4th quarter expenses by $80-100 million, and even with the recent decline in fuel prices, the Postal Service will still see significantly higher expenses for fuel, electricity, and transportation services than in the 4th quarter of FY 2007. Given these headwinds, the Postal Service will do well to hold expenses to an increase just below what it experienced in the the 3rd quarter. Using a 0.8% increase over FY 2007, 4th quarter expenses would be $19.181 billion and full year expenses would be $77.534 billion.

Again the Postal Service does not provide a forecast for FY 2009 expenses but identifies that the employee COLA could increase costs by $1 billion. It is not clear whether this increase reflects the potential impact of normal attrition or the VERA. The Postal Service will also experience higher fuel, electricity, heating, and transportation costs through at least the first two quarters even if oil drops down to $100 a barrel. The Postal Service may see some relief in the third and fourth quarter as current oil price levels are below the highest levels of that period. Clearly, in order to bring its costs closer in line to revenues, the Postal Service will need to reduce work-hours in the first three quarters of FY 2009, including the impact of the VERA, by an amount exceeding the 40 million work hours that it achieved in FY 2008 along with cost savings in all other areas.

Net Income Outlook

The Postal Service did not provide a net income outlook. Through 3 quarters in 2008 its net loss is $1.1 billion. Based on the assumptions and estimates listed above, the Postal Service would appear likely to end the year was a loss of $2.269 billion. Even if the Postal Service was able to hold all expenses in the fourth quarter at FY 2007 levels, the FY loss would likely exceed $2 billion.

The outlook for net-income in FY 2009 would appear to be not much better. If revenue remains flat, the Postal Service would need to cut expenses by over $3 billion in FY2009 to break even. (The $2.3 billion loss in FY 2008 plus the increase in costs due to the COLA and difference in the fuel prices over FY 2008 in the first two quarters of FY 2009.) Such a large reduction in expenses is an ambitious goal. However, the Postal Service may have little choice but to seek to set a goal close to this amount to ensure that it will be in good shape financially when the economy improves in FY 2010.

Postage Rate Outlook

The Postal Service provides mailers with no indication of what future rate increases will be in the 10-Q. However, given the financial situation, mailers should assume that the Postal Service will raise rates by the maximum amount permitted by law for all products subject to the rate cap. At this moment the index is 3.7% but will likely be higher by the time the Postal Service proposes next year's rate increase. An average increase somewhat above 4% would seem to be a reasonable assumption for planning purposes. Given that cost of fuel is just beginning to trickle through into other prices, assuming that postage rates will rise another 4% in 2010 as well would seem to be a reasonable starting point.

While the CPI-U index provides information on the average rate increase, it does not say much about how individual products will be affected. Among the factors that may affect individual mailers are:

  • The impact of the unitary postage rate for First Class single piece on the total increase from First Class mail and the automation and pre-sort discounts. The Postal Service may choose to not raise stamps 2 cents if by doing so it must raise discounts beyond what it believes is financial prudent.
  • The additional ounce 1st Class rate adjustment may reflect the need to make the transition between First Class and Priority mail rates rational. If priority mail rates increase by more than the CPI-U then the additional ounce rate could be expected to rise by a larger percentage than the first ounce rate.
  • Drop shipment discounts may be constrained by the CPI-U limitation. It is possible that discounts may not adequately reflect the rise in fuel costs thereby causing some drop-shipped mail to be transported by the Postal Service.
  • Parcel rates under the price cap (e.g. single piece parcels, media mail, and bulk printed matter) could become a test case for exemption from the CPI-U limitation. These products have a higher transportation cost component than other mail products and the CPI-U limitation may force these rates to be below financially prudent level.

For competitive products, mailers should expect that the Postal Service will raise rates by a percentage equal or larger than what private sector carriers do in January. The Postal Service will likely take into account the impact of increases that have already been implemented by its competitors in the form of fuel surcharges when it raises rates next May. (Given that a substantial portion of the Postal Service's parcel business is first handled by FedEx or UPS, mailers may have seen the impact of the fuel surcharge on drop-shipment rates already.) The Postal Service's competitive product price increases could be constrained by the increase in rates for single piece parcels and the First Class additional ounce rates.

Legislative Changes Suggested by the Current Financial Challenges

This review of the current financial challenges facing the Postal Service suggests that it may need some relief from Congress in order to work its way through the current economic downturn. Specifically, two actions could ease the Postal Service's ability to hold rates below the cap and prevent its financial position from deteriorating over the next few years.

  • Extend the period over which the Postal Service must fund its retiree health care obligations. An extension of the 10 year period to 15 or 20 years would reduce the hurdle required to ensure that revenue matches costs. This could prevent significant cuts in service or reductions in force that would otherwise be required
  • Place all parcel rates under the competitive banner. By doing so, the Postal Service can ensure that its rates for all parcels remain remunerative and that rates for both individual and commercial customers remain both reasonable and competitive. This may mean that parcel rates will rise more than the cap in years when fuel and labor costs rise faster than CPI-U and will rise less than the cap in years that either competitive pressures are greater or cost pressures are less severe than they are now. Removing parcel rates from the regulated sector may be necessary to ensure that the Postal Service can offer universal access to its parcel delivery network to individual and small business customers.

Neither of these changes would require direct government outlays. The first one could have a budgetary impact that would have to be dealt with in the legislative process.

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