What happened
According to data from S&P Global Market Intelligence shares in United Parcel Service (UPS 1.64%) are down 10.8% at the halfway point of 2018. Although the stock price closely follows perennial rival FedEx Corporation (FDX 3.82%) it's fair to say that UPS has had some stock specific issues to deal with alongside industry challenges.
Image source: United Parcel Service website.
There are four separate factors for investors to focus on:
- In common with FedEx, UPS suffered a hit to profits due to the difficulties in servicing peak demand spikes in the holiday season in 2018.
- The escalation of political rhetoric regarding protectionist measures on trade is obviously creating concern for companies that rely on global trade for a large part of their earnings.
- Despite the unlikelihood that Amazon.com's growing delivery services offer any kind of existentialist threat to UPS and FedEx the fear of it could lead the market to sell off the package delivery giants.
- On the first-quarter earnings call in February UPS negatively surprised the market with regard to its capital spending plans, and it's clear that elevated levels of spending will constrain free cash flow generation in the next few years.
So what
The difficulty in servicing peak demand -- neither UPS or FedEx can be expected to build out a network solely for a few peak days trading in a year -- experienced in the winter highlights the extra risk that must be factored into both stocks. Meanwhile, the threats from Amazon and/or trade wars are just, at this stage, fears, rather than actuality.
Turning to the stock specific issue, the ramping of capital expenditure expectations is likely to have disappointed investors. CFO Richard Peretz had this to say with regard to the share of revenue to be dedicated to capital spending "at the end of the day, the next few years, we expect these kinds of levels, somewhere between 9% and 10%, 8.5% and 10% of revenues to stay."
As you can see below, these levels are far higher than UPS has had in the recent past and imply that UPS is increasing its spending on a par with FedEx.
UPS CAPEX to Revenue (Annual). Data source: YCharts.
Now what
Looking ahead, there's little that UPS can do about the market's fears over so-called trade wars and/or Amazon expanding its own delivery services. Instead, investors should focus on whether UPS is able to grow profit margin as e-commerce delivery volumes grow.
Similarly, UPS needs to convince investors that it's got a handle on the kind of capital spending needed to develop its network in order to service growth.
