FedEx Corp. (FDX +1.75%) and United Parcel Service Inc. (UPS +2.30%) share end markets, and they tend to report in the middle of the other's earnings quarters, so there is usually a strong read across their earnings reports. With this in mind, let's take a look at five key conclusions from FedEx's quarterly results from June 2016 and what they indicate about UPS' upcoming earnings.
FEDEX IS INVESTING IN ITS GROUND NETWORK. IMAGE SOURCE: FEDEX CORPORATION.
The economy is slowing
Obviously, you don't have to just rely on FedEx for economic forecasting, but the package delivery company's projections are highly relevant to UPS investors because they include FedEx management's predictions for the economy. Unfortunately, the trends in FedEx's end markets don't make for good reading.
The following table shows how the forecasts for fiscal 2016 have been progressively lowered in the last few quarters.
| Forecast for fiscal 2016 | Q1 September | Q2 December | Q3 March | Q4 March |
|---|---|---|---|---|
| U.S. gross domestic product | 2.8% | 2.6% | 2.2% | 1.8% |
|
U.S. industrial production | 2.6% | 1.9% | 0.6% | (0.6%) |
| World GDP | 2.9% | 2.8% | 2.5% | 2.3% |
DATA SOURCE: FEDEX PRESENTATIONS. QUARTERS REFER TO FEDEX'S FISCAL QUARTERS.
The negative trends are concerning and place more pressure on both companies to generate growth through more positive secular trends such as e-commerce-based deliveries.
E-commerce business remains strong
In this context, it's good news that FedEx continues to report burgeoning e-commerce growth. Fortunately, the trend appears to be continuing, with Mike Glenn, CEO of FedEx Corporate Services, pointing out that e-commerce growth "continues to outpace GDP growth both in the U.S. and globally." In addition, he outlined the "significant investments" made in "expanding our global transportation portfolio and e-commerce capabilities around the world including the acquisition of TNT" and the introduction of FedEx CrossBorder -- an e-commerce solution that helps e-tailers deal with "cross-border selling challenges," according to FedEx.
In short, e-commerce growth is strong and FedEx continues to invest in order to generate growth in a moderately growing globally economy. UPS can do the same.
Impact on capital spending and cash flow
As noted above, FedEx is expanding capacity, but that doesn't come for free. In fact, management's forecast for capital spending in 2017 is $5.1 billion (including $2 billion at Ground in order to grow its network) and, as you can see below, this implies a relatively high rate of capital spending for 2017. Incidentally, the figure excludes TNT-related spending.
DATA SOURCE: UPS AND FEDEX PRESENTATIONS. DATA IS FOR THE FISCAL YEAR.
Moreover, on the earnings call, FedEx CFO Alan Graf discussed how capex in the range of 6% to 8% of revenue was the "sweet spot," but that the company would be above that for the next couple of years.
In contrast, UPS is expecting capex as a share of revenue to be in the 4.5% to 5% range in the next few years. Given the increasing pressure on FedEx to expand capacity to deal with e-commerce growth, will UPS be forced to raise its spending above that range? It's something to look out for.
As you can see below, FedEx is increasingly spending on its ground network, a sure sign that e-commerce growth is creating the need for extra investments.
DATA SOURCE: FEDEX PRESENTATIONS.
UPS' Next Day Air growth could slow
In recent quarters, UPS has seen its more expensive Next Day Air services grow volume more than its less expensive, and slower, Deferred and Ground services. That's good news from a revenue perspective, but will it continue?
FedEx's results suggest that UPS' good run in this regard could be about to end. For example, FedEx's total average daily package volume in its Express segment grew just 0.2% in the fourth quarter, compared to the 10% increase in Ground.
PACKAGING COMES IN ALL SHAPES AND SIZES. IMAGE SOURCE: UNITED PARCEL SERVICE.
Pricing initiatives are working
Clearly, both companies are seeing strong e-commerce-related growth, but there are challenges. We've already seen how FedEx is increasingly spending on its ground network, but there is also a challenge for FedEx and UPS in influencing customer behavior. In a nutshell, both companies need to encourage their e-commerce customers to pack efficiently so they can maximize profitability.
One way to do this is through pricing initiatives. For example, both have expanded dimensional-weight pricing -- packages are priced on a combination of weight and size. The news from FedEx's latest results is positive, with the company reporting an increase in Ground revenue per package from $7.49 in the last year's fourth quarter to $8.01 this year.
It's an indication that UPS' pricing initiatives will also bear fruit in its coming quarter.
Looking ahead
All told, FedEx's results indicate that strong e-commerce growth will help mitigate the effect of weakening economic growth. Meanwhile, FedEx and UPS pricing initiatives appear to be generating yield improvements. On a less positive note, demand for premium services may wane, and look out for UPS' management commentary on the need to make capital expenditures to deal with strong e-commerce demand.
