FedEx Corporation (NYSE:FDX) gave its second-quarter results a few days before Christmas, and what management had to say is highly relevant for investors in key rival United Parcel Service, Inc. (NYSE:UPS). Here's a look at five things from the earnings presentation that give clues to what UPS will report in its next earnings.
Both companies have had issues dealing with peak demand during Christmas, most notably with UPS in the winters of 2013 and 2014. It's not just about the quantum of demand; it's also about the timing of peak days. In the winter of 2014, UPS managed to invest in too much capacity -- hiring extra staff, for example -- on the wrong days and disappointed investors by incurring high costs. Since then, both companies have taken measures to try to influence customers to smooth out demand during peak season. That way it's easier to predict when peak demand days will come.
With this in mind, CEO Fred Smith's affirmation that "service levels have been outstanding" is a positive, as is his argument that FedEx will see "disproportionately higher demand" in Christmas week because Christmas Day itself fell on a Sunday this year. This commentary suggests that peak demand days are easier to predict this year, auguring well for UPS too.
UPS and FedEx are both increasing prices and taking measures to increase surcharges. Of course, such measures require that both companies have pricing power to make them stick. One way to judge this is by looking at trends in volumes and pricing, and there is good news on that front from FedEx's earnings.
For example, FedEx ground yield rose 4% but it had no negative effect on volume, which rose 5%. Matters were less conclusive at FedEx express, where yield grew 1.4% but average daily volume grew just 0.5%. However, volume growth was held back by a hurricane, a typhoon, and a customer shifting deliveries to another period.
Nevertheless, the strength in FedEx ground volume suggests UPS won't have much of an issue pushing through the 4.9% rate increase for ground -- effective Dec. 26.
While FedEx ground volume and pricing wasn't a problem in the quarter, margin certainly was. In fact a whopping 12.2% increase in operating expenses caused ground margin to decline from 13% to 10.5% on a year-on-year basis. The end result was a 9.1% increase in ground revenue translated into an 11.6% fall in ground operating income.
The reason for the cost increase -- associated with significant network expansions to service future e-commerce growth -- is a salutary reminder to UPS investors that while e-commerce growth looks assured, it will also create pressure on costs. Look out for any commentary from UPS on this issue.
The inevitable Amazon discussion
This issue is raised because of the fear, rather than the reality, that Amazon.com, Inc.'s (NASDAQ:AMZN) expansionary activity in delivery threatens to eat UPS's and FedEx's lunches. In this regard, the opening of four new hubs and 19 automated stations illustrates the scale of the operations the incumbents run.
Indeed, Smith went on to point out that some of the operations were "250 acres plus, and the amount of sortation equipment inside are measured in miles." Smith noted his surprise with "the misunderstanding of the gigantic scale of the FedEx and UPS operations" -- all of which suggests that fears over Amazon's delivery expansion plans are somewhat misplaced, so there's no need for FedEx and UPS investors to be unduly worried.
It's no surprise to see FedEx and UPS investors apprehensive about the incoming Donald Trump presidency. Trade wars are obviously not a good thing for package delivery companies, and Smith reiterated his call for open markets and policies designed to promote trade. Nothing he said is contrary to Trump's statements, but the shift in emphasis in looking after America's blue-collar interests first might cause some changes to trade patterns.
On a more positive note, CFO Alan Graf welcomed Trump's tax plans such as "materially lowering the tax rate, the effective territorial treatment of foreign earnings, and current expensing of capex" and believes they will improve revenue growth, by way of a growing economy, and earnings, through a lower tax rate. UPS is likely to see a similar effect.
Based on what FedEx management said, cautious investors will want to keep an eye out for statements on UPS's trading during Christmas week. It's likely to see high e-commerce demand. And don't rule out future investment by UPS in its ground network.
On the other hand, both companies look to have the pricing power to push through price increases without any negative impact on volume. Moreover, fears over Amazon seem misplaced, and a Donald Trump presidency promises a positive impact for both companies. All told, FedEx's earnings read across positively for UPS.