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Is It Time to Buy UPS and FedEx?

The share prices of package-delivery giants UPS (NYSE: UPS  ) and FedEx (NYSE: FDX  )  have been down in the high-single digits in 2014. Essentially, the market is punishing them for a difficult Christmas period when high-profile delivery delays disappointed consumers and online retailers alike. Has this created a buying opportunity in UPS and FedEx?

UPS and FedEx have been unfairly criticized
The widely publicized problems with Christmas deliveries led to UPS and FedEx receiving substantive amounts of criticism, but investors need to appreciate that the issues were partly caused by an unusual confluence of incidents. From an investment perspective, the main concern is that the problems were somehow systemic, which would necessitate greater investment in order to rectify them. On the other hand, investors need to bear in mind the following points about recent events:

  • The Christmas selling season was unusually short, as it contained six fewer days than last year.
  • Extreme bad weather in the U.S. caused significant logistics problems. 
  • Online retailers increased their last-minute promotions, and consumers delayed decision making until late in the season.
  • E-commerce shipment growth came in far higher than expected by UPS.

In a sense, many of these events are related. For example, extreme cold weather may have encouraged more people to buy online. Also, it may have led to a bottleneck in online purchases by causing consumers to delay their ordering until the last minute as they hoped for better weather to go shopping in the malls. In addition, severe snow storms shut down UPS's operations for over three days in places like Texas and Oklahoma. All of this came together to make conditions very difficult for UPS and FedEx.

Indeed, UPS saw a dramatic 12.7% decline in adjusted operating profit within its U.S. domestic package segment.

Source: UPS Presentations

While these issues hurt short-term performance, they are unlikely to repeat in the future in the same manner. Furthermore, the trend toward e-commerce is actually one of the three key long-term demand trends which affects UPS and FedEx.

Long-term trends for UPS and FedEx
The first trend is the increasing willingness of customers to trade-off timely delivery for cost. UPS's management explicitly recognized this trend in the recent conference call by saying that "customers put greater emphasis on cost rather than time in transit". A quick look at how FedEx's earnings have shifted toward its ground segment (from express) reveals the importance of this trend.

Source: FedEx Presentations

The second trend is the shift toward e-commerce, which obviously creates long-term growth opportunities for package delivery companies.

The third trend is the somewhat more problematic issue of increasing protectionism in the global economy. Investing Fools already know about this trend and how it affects the international operations of FedEx and UPS. Simply put, increased protectionism leads to slower growth in global trade and therefore cargo freight activity as well.

UPS and FedEx need to invest anyway
Putting these three trends together quickly leads to the conclusion that both companies will have to invest in the future. They will need to structurally shift investment toward supporting their slower delivery services and handling the burgeoning e-commerce demand. This is actually good news. Investors should support companies that are investing for growth.

Moreover, the decline in global trade looks to have abated and trade could turn into a positive driver going forward.

Source: IATA

Furthermore, UPS's management was clearly keen to invest in technology in order to ensure the "timely and accurate visibility of shipments". One such solution is machine vision technology from a company such as Cognex (NASDAQ: CGNX  ) . The company is actively trying to expand its logistics sales (it believes this market is worth $250 million), and given the emphasis that companies like UPS and FedEx are placing on technology investment, it's not hard to imagine that Cognex will be successful.

The bottom line
In conclusion, the sell-off looks a little harsh in the context of an unusually difficult Christmas period. Furthermore, long-term growth in e-commerce is actually a big plus for UPS and FedEx, and Fools should look at this as a long-term positive. Furthermore, the investments that these companies are making to rectify any future problems with network capacity are also measures that should help their overall efficiency. If you believe that the global economy is going to improve in-line with economists' forecasts then the current sell-off could prove a good buying opportunity in FedEx and UPS.

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Lee Samaha

Investing commentary to help retail investors outperform professionals. I research and write post-earnings analysis of leading companies. Follow me on Twitter or Google+ to receive quick and thorough earnings analysis of your favorite stocks.

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