UPS and FedEx: Facing Economic And Policy Risks, Benefiting From Industry Tailwinds

Transportation stocks have underperformed the broader stock market over the past year.  United Parcel Service (ticker: UPS) and Federal Express (ticker: FDX), the two largest U.S. freight-shipping-courier companies, have not escaped this relative underperformance.  Although UPS and FedEx face near term headwinds and are (at times) highly correlated to the broader U.S. and global economies, both companies may benefit from longer term tailwinds as they optimize their operations.

Within the transportation sector, stock underperformance has been uneven with several airline, rail, shipping and freight companies performing well while their brethren demonstrate ugly charts.  The Down Jones Transportation Index is up 12.65% over the past year while the S&P 500 has returned 15.13% over the same time period.  Since President Trump was elected, transportation stocks have performed roughly in line with the broader market.

Bloomberg TRAN vs. SPX

Both UPS and Fedex have underperformed both the index and have been laggards within the transportation sector as well.  Honestly, FedEx looks unattractive on a chart and UPS looks downright ugly!  This is especially true since the end of January.

There is also considerable nervousness around ground delivery margins.  Business to consumer ground delivery is frequently a lower margin business.  When a consumer places an online order for something small and not terribly valuable (e.g., a book) that consumer expects free or immaterial shipping charges.  It's simply a consumer expectation at this point.  UPS' most recent quarterly guidance declared margin compression from B2C services as a risk.

The two other big negatives to UPS and FedEx (and the entire transport sector) are capital expenditures and currency translation risks.  When UPS recently announced it was pulling capital expenditures forward, the stock sank 10%.  Additionally, these companies derive a large portion of their sales from ex-dollar jurisdictions.  There is no denying these two risks.  Note, however, that these two risks are associated with UPS and FedEx no matter the investment or economic environment.

If this all sounds very negative for freight-shipping-courier companies like UPS and FedEx, it is.  There is no doubt that near term risks abound.  However, there are thematic or industry-changing tailwinds that may benefit these companies over the longer term.

• First, the sustained lower cost of oil, gasoline and jet fuel: although the recent correlation between share price and oil price has been negligible, theoretically, low oil prices are a benefit to companies like UPS and FedEx.  Oil is a large import price for their operations.
•  Secondly, improved pricing power: there is some expectation that shippers will increase rates.  Amazon’s prime, same day delivery, and similar “on demand” shipping may increase profit margins.  Last year both UPS and FedEx increased their shipping charges by close to 5% and it is anticipated that could happen again in 2017.
• Thirdly, technological innovation: arguably companies like UPS and FedEx are giant technology companies.  Their use of big data, cloud services, on-demand analytics and forecasting continues to improve and optimize their operations.  The technology investments these companies have made are meaningful.  We’ve all heard the story about the UPS drivers avoiding left turns.  That’s a real thing and for a reason.
• Fourthly, growth of e-commerce: the retailing of everything is online at this stage.  That wave just continues and it implies more business for freight, shipping and courier companies.  We might not have Sears much longer but the ability to order any widget from your phone is only increasing.

Besides those four industry tailwinds, the general growth of the economy will be telling for freight-shipping-courier stocks.  As a general rule of thumb, these companies grow their volumes in line with U.S. output or Gross National Product.  Consider that last year the U.S. economy (Gross Domestic Product) grew at just 1.9% while this year the consensus forecast is for the economy to grow at 2.3%.  That may still be a low absolute number, but compared to 2016 it is over 21% larger and should augment world growth forecast to be 3.0%.

Both company-specific and sector risks should be considered when analyzing companies like UPS and FedEx.  However, discarding the transport sector babies with their bathwater, ignores many potential tailwinds for patient capital.