It's almost impossible to look at a set of quarterly results from FedEx (FDX 2.01%) without considering what the read-across will be for United Parcel Service (UPS 0.96%). Given that the fiscal 2020 fourth-quarter results FedEx delivered on June 30 were warmly received by the market, it would seem appropriate to take a look at what UPS investors should be expecting when their company next reports on July 22. Here's the lowdown.
The bar has been set by FedEx
FedEx's earnings excited the market because the margin on the company's ground delivery business was a lot better than many had feared it would be. It's no secret that both that UPS and FedEx have had to adapt to a unique set of operating conditions due to the COVID-19 pandemic, all of which have placed pressure on their profit margins.
In a nutshell, the lockdowns and production shutdowns caused higher-margin business-to-business (B2B) deliveries to collapse, while simultaneously prompting a surge in less-profitable business-to-consumer (B2C) e-commerce deliveries. In addition, both companies have been hit by a host of extra expenses due to the coronavirus pandemic, while their revenues for freight and international deliveries have slumped.
These dynamics have already been made clear in both transportation companies' earnings reports. For example, in UPS's first quarter (which ran from January to March), revenues from its international package and supply chain and freight segments declined due to economic weakness, while U.S. domestic package segment revenue increased by 9.2%. But the same margin pressures discussed above caused that segment's profit to decline by 42%. The company's overall profits fell by 26.4% in the quarter.
Meanwhile, in FedEx's fiscal fourth-quarter -- which ran from March to May, and therefore included much more of the lockdown period -- the company experienced a similar dynamic. FedEx express revenue was down 10% and freight revenue fell 17%. Meanwhile, in FedEx's ground segment (which is where the bulk of e-commerce lies) a 20% increase in revenue (due to burgeoning B2C demand) produced a 17% decline in operating income.
Putting this all together, it's clear that when UPS gives its second-quarter earnings report (for April through June), it's likely to reflect a similar dynamic of year-over-year revenue and profit declines in its international and supply chain/freight segments, while strong volume and revenue growth in its domestic package segment revenue growth will produce a weaker margin performance.
The key metric to follow
The real question in terms of UPS's domestic package segment is not "Will profit margins be weak?" It's "How weak will they be?" In addition, there's the deeper question of what these issues mean for its long-term margin-growth potential as B2C e-commerce grows.
One clue can be found from the sequential trends in FedEx's ground margins. As you can see below, the year-over-year ground margin declined as package growth soared. However, ground margin increased on a sequential basis. In itself, this is a good result considering the difficult conditions in the quarter.
As such, investors should also expect some sequential improvement in UPS's U.S. domestic package margin when it reports its second-quarter earnings. There are three key reasons why.
First, the segment's margin fell significantly in the first quarter, which gives it a lower bar to leap in the second quarter.
Second, during FedEx's earnings call, Chief Marketing and Communication Officer Brie Carere said its overall business had experienced "week-over-week improvement in our business since hitting the bottom in mid-April." This augurs well for UPS considering its quarter began in April.
Third, FedEx's Carere also said "since the end of April, however, we have seen week-over-week growth in our business-to-business segment." Again, if this trend is replicated at UPS in May and June, those higher-margin B2B deliveries should blend in to support the segment's margins.
UPS shareholders have cause for optimism
While there's no guarantee that UPS will report a similar relative improvement in its earnings, the two companies operate in the same end markets, and some of the underlying improvements experienced by FedEx in its last quarter will surely be felt by UPS as well. In this context, it's reasonable to expect it to report a good set of results too. That would go a long way toward reassuring investors that margin expansion and volume growth can occur together over the long term as e-commerce deliveries grow.