Given the doom and gloom around the ongoing trade conflict and a disappointing set of results from perennial rival FedEx (FDX +2.87%), it's somewhat surprising to see that shares of UPS (UPS +1.31%) are actually up more than 18% so far this year -- slightly ahead of the S&P 500. It's an impressive performance given the circumstances, and it suggests the company has turned the corner following a few years of underperformance.
That said, the upcoming third-quarter results will probably contain a mix of positives and negatives. Here are three points to focus on when UPS reports earnings on Oct. 22.
1. International package volume
Unfortunately, there's little that UPS or FedEx can do about global trade conditions, and it's fair to say that they are both on the front line of any trade dispute. Whenever you invest in the transportation industry, such as with railroad stocks or shipping stocks, you always get exposure to the fortunes of the economy.
Image source: Getty Images.
While FedEx has its own specific issues to deal with -- not least the integration of TNT Express and adjusting to the ending of contracts with Amazon -- slowing global trade hurts both companies. As you can see below, the international package segment is a significant contributor to UPS profitability.
Data source: UPS.
The key variable to follow in the international package segment is average daily package volume. FedEx reported weakness in international volumes in its last quarterly earnings, and it would be surprising if UPS didn't report the same in its upcoming quarter. Indeed, UPS's international package revenue has declined in the last two quarters, and year-over-year volume growth turned negative in the second quarter.
Data source: UPS.
2. Fully benefiting from e-commerce growth
It's well known that FedEx and UPS have a growth opportunity from burgeoning e-commerce deliveries, but the question is whether they can expand operating margin and free cash flow in the process of making those deliveries. E-commerce deliveries to residential addresses can be expensive, especially if they are inefficiently packaged or contain bulky items (mattresses and the like). In addition, FedEx and UPS have both had to significantly ramp up capital expenditures in order to service future growth.
In this respect, the key number to focus on is the one that UPS management flagged on the last earnings call: the growth in the cost per piece. A lower number is better since it implies UPS can improve its profit margin as its investments in increasing and improving its network are bearing fruit.
|
UPS U.S. Domestic Package |
2017 |
2018 |
Q1 2019 |
Q2 2019 |
|---|---|---|---|---|
|
Total cost-per-piece growth |
5.5% |
6.6% |
2.8% |
0.5% |
Data source: UPS.
3. Volume growth and pricing
If UPS is on track to slow the growth in the cost per piece -- or even reduce it -- then it's likely to feed through into an increase in U.S. domestic package margin and profitability. As you can see in the chart below, this has been an issue in recent years, but it appears that UPS began to turn the corner in the second quarter.
Data source: UPS.
Looking ahead into the third quarter, one of the key things to look out for is the maintenance of revenue growth in the segment, and that's going to come from a good combination of volume and pricing. FedEx and UPS have been expanding capacity to meet e-commerce demand so volume growth looks assured. The question is: What will pricing be like?
Data source: UPS.
Looking ahead
Given the negative outlook from FedEx on its last earnings call, and the ongoing trade dispute, it won't be surprising if UPS reports some weakness in international package volume -- particularly export volumes. But on a more positive note, UPS appears to be starting to see the benefits of its substantive investment in its network in terms of improving margin and profits in its U.S. domestic package segment.
All told, it's likely to be a mixed report, but if UPS can demonstrate underlying improvement in its own operations, then investors who are confident that the trade dispute will eventually be resolved will feel good about buying the stock.
