Are the Postal Service's Earnings Forecast Too Optimistic?

Readers that are expecting an answer to the question in the title will be disappointed.   The truth is I do not know.   However, I do know that the most recent forecasts, or at least those contained in the exigent rate case are woefully out of date even though they are at worst 6 months old.

The problem with the financial projections does not lie with the Postal Service or those that are responsible for their development.   At the time the forecast, they represented the best understanding as to the near term (under 2 year) prospects for Postal Service revenues and costs given the economic data and management plans at the time they were made.   The problem exists because 1) the regulatory lag associated with preparing and litigating any proceeding before the Postal Rate Commission; 2) the lack of shareholders and investment analysts that are developing independent forecasts that force enterprises to announce how changing economic conditions affect future earnings at least quarterly and in the cases of many companies monthly; and 3) the risk that the Postal Service faces that the time frame for litigating proceedings before the Commission could lengthen if it would regularly suggest that the numbers that it presented were better or worse than they now are.

Now why would I be concerned that finances may be too optimistic?

The primary reason is that the general understanding of economic growth is worse today than it was 6 months ago.  Why?

1. The consumer has become significantly more risk adverse than ever seen before.   This affects the economy in a number of ways.   Consumers are investing their savings in the most secure investments possible (e.g. CD's and Treasury Bonds) and no longer see either real estate (i.e. their home) or stocks as reasonable ways to save for retirement or children's college tuition.  Consumers are stopped borrowing as they realize that the cost of loans now is greater than the change in the value of the goods they plan to purchase, whether that is a major appliance, car, or home.   If one believes that prices are not going to rise, it may be cheaper to save rather than borrow.   That explains why lay-a-way programs are starting to make a comeback.   Finally,  consumers are changing views on what they believe are necessities.  Whether this reflects the state of the economy or changing demographics does not matter.   Items such as electric dryers, microwave ovens, and air conditioners are considered to be necessities by fewer consumers tan prior to the recession with the shift occurring before the recession began.
   
2. Companies focused on selling everything from appliances to shoes to consumers realize that their projections for consumer spending during the back-to-school and Christmas seasons were overly optimistic.   To the extent that these companies can, they are scaling back purchases to get their inventory more closely aligned with consumer demand.   Companies selling to consumers realize that managing overhead, selling, and inventory costs are critical if they are going to meet profit goals.  Those that were late to this realization will likely force higher levels of promotions during the upcoming selling seasons pressuring corporate profits.
   
3. The way we use computers, telecommunications, and energy have shifted both businesses and consumers toward technologies that require less labor to produce and maintain.  In addition, service and manufacturing companies have used these changes to reduce the use of labor intensive processes that take advantage these technologies.  The shift has resulted in the double digit unemployment among blue-collar workers which may not improve in the lifetime of the employees affected.

The slowdown in the economy should affect mail volume and revenue as much of the Postal Service's business is economically sensitive.  However, not all is bad news. 

• The Postal Service is likely to have a good 1st quarter in FY 2011 as political and retail advertising max out available broadcast advertising capacity and look to mail as the only advertising media that has the capacity to reach voters or customers. The increase in demand may have a negative impact on costs as the bump in volume may result in a bump in overtime to deal with peak volumes in October, 2010.  Also, this is a one time bump in revenue and volume and should not be mistaken for a longer term trend as the volume gained this fall will not come back again until the 2012 election.
  
• Costs for energy and labor will likely not rise much.   Lower energy prices will hold down transportation and facility costs.  Depending on the energy price assumptions used in the forecast, costs may be lower than now projected.

Given these trends it is clear that forecasting the Postal Service's finances need a second look.  In addition, it would seem that if the Postal Service wants to make any major effort to reduce its overhead and capacity, it may make sense to begin planning for changes that will begin after the January 1, 2011.   Once the election and shopping seasons are over, demand will be back down to normal seasonal levels reflecting only the general state of the economy and the technological shifts away from mail.

Filling in the Gaps

At the Board of Governor’s meeting on Wednesday, September 24, Postal Service’s CFO Harold Glen Walker provided only a limited picture of the Postal Service’s current and near term and financial condition. He did not present as expected either a forecast of a projected loss for the remainder of the fiscal year, nor did he present an integrated financial plan for FY 2009 as was expected from the agenda e-mailed to the press. His only clear statement on finances was that the “4^th quarter decline has occurred at an accelerating rate.” The postal community needs more information than that, and this post will provide an analysis that hopes to fill in the gap in public information that was left behind at the conclusion of the meeting.

In particular this post and the ones that will follow, I will provide:

• an updated forecast of the Postal Service’s loss for FY 2008;
• an examination of the economic and business trends that will drive revenue and costs in the remainder of the fiscal year and next fiscal year;
• the challenge of doing any forecasting in today's economic environment;
  
• some thoughts on strategic planning; and
  
• a preliminary forecast for FY 2009.

The fourth quarter is clearly one of the most difficult periods that the Postal Service has faced in its history. The release of the Postal Service's revenue and expenses accounts through August shows that the Postal Service's loss so far this year is how challenging this period is. So far this quarter, revenue is$11.850 billion and expenses are $13.025 billion, producing a two month loss of $1.176 billion.

The loss so far in the fourth quarter is driven by a 4.7% decline in revenue, a 1.3% increase in expenses, and a $329 million workers compensation adjustment. Extrapolating this trend through September would result in a quarterly loss of $2.168 billion and a fiscal year loss of $3.326 billion.

The increase in expenses in these two months appear likely to continue through the remainder of the quarter. During the 4th quarter, COLA payments raised labor costs. Changes in energy prices raised expenses by over $140 million as noted in transportation, gasoline, natural gas, heating oil, and electricity accounts. Given that much of the increase in energy prices happened after the beginning of 2008, this increase in cost will clearly continue through the remainder of the quarter. The Postal Service will be able to cut the projected deficit on the expense side only if they can make substantial reductions in work hours, reduce contracted and postal transportation, or have accounting adjustments that affect final expense totals.

The decline in revenue raises some serious questions about the near term business prospects of the Postal Service, particularly since it raised rates just a few months ago. The decline in revenue potentially reflects two trends that were not present previous. First, the decline in revenue most likely reflects a volume decline that is greater than the 4.7% decline in revenue given the increase in rates. Second, the decline in revenue most likely indicates that both long term trends and the economic downturn are having a greater impact on the Postal Service's products that generate more revenue-per-piece than others.

Looking at the revenue figures in more detail does provide some hints as to which products are driving the revenue decline. In particular the revenue data shows that:

• Revenue from those payment categories most likely to represent single-piece First Class mail declined by 6.75% or $158 million. This includes revenue from stamps, other than precanceled stamps, PC Postage, and low speed meters. The decline in revenue here is only marginally larger than the decline in single piece revenue in the third quarter (5.6%). During that quarter, single piece mail volume declined by 9.8%. This fourth quarter will likely show the first double-digit decline in single piece mail volume. As the downward trend in single-piece mail volume, that presents a faster decline in each subsequent year, began almost a decade ago, the decline in First Class Single Class mail is unlikely to return when the economy returns.
  
  
• The 7.3% or $242 million decline in revenue in Standard Mail permit and pre-cancelled stamp revenue in the 4th quarter shows the intense impact of of the economy on revenue sources linked to advertising. Regular Standard Mail permit revenue declined by 7.4% and Non-profit Standard Mail permit revenue declined by 5.9%. Both of these products saw declines in permit revenue greater than that experienced by the Postal Service as whole. In the 3rd quarter, standard regular mail volumes were down by 6.8% and non-profit volumes rose by 2.9%. In the 4th quarter, the Postal Service may be seeing large single-digit or double-digit declines in regular Standard mail volume and single-digit declines in non-profit mail volumes. The Postal Service will get a small bump in non-profit mail in September from the election but much of the election effect will occur in the next fiscal year.
  
  
• All other postal products do not appear to be as adversely affected by the economy or long-term secular trends. However, the impact of the economy on periodical revenue may be delayed due to advertising page commitments for July and August may have been made before the depth of the downturn was as clear. The Postal Service may be seeing problems in periodical revenue in the next fiscal year.

Given that the economy has slowed further in September, with the greatest impact occurring in the mail intensive financial service businesses, the Postal Service is unlikely to report better revenue trends in its 4th quarter RPW report based on one additional month of data. Therefore, extrapolating the year-to-year change in revenue feels like a reasonable assumpt ion without further data.

If the Postal Service's projected loss is even close to the $3.3 billion that an extrapolation would suggest, then the sooner the Postal Service begins to prepare its stakeholders for the end-of-the-year reports the better. Holding back on bad news is unlikely to make life any stakeholder including Postal unions and their leaders, employees, mailers, Congress, and Postal Regulatory Commission.
Service

Oct 1, 2008 Correction: Since this observation was posted, I have learned that the Postal Service has told its unions, and management associations that it expects its losses for the year will be $2.3 billion, $1 billion less than what is projected in the observation above. I take the Postal Service's statement to be authoritative and all future observations will use this figure. The difference most likely represents one time expenses or accounting adjustments to either revenue or expenses that I did not account for. I should have noted that possibility in the original post.

The APWU reported that the Postal Service has stated that mail volume decline by 12%, most likely in the 4th quarter. This would match the revenue decline identified above. Combining the volume decline with the revenue decline really highlights that the slowdown in the economy is hitting the Postal Service particularly hard.