During most of the year, package delivery companies FedEx Corporation (FDX +3.79%) and United Parcel Service (UPS +2.05%) attract little attention from the public, but that all changes come the holiday season if they don't deliver packages on time. However, investors should also focus on the holiday period because dealing with peak demand is probably the biggest variable in both companies' earnings. Let's look at what both companies are doing to prepare for peak demand during the upcoming holiday season.
FedEx Ground has coped with peak demand better than UPS has in the past two years. Image source: FedEx.
FedEx Corporation
It's fair to say that FedEx has had a lot less difficulty than UPS in dealing with surging peak demand. FedEx had a relatively mundane holiday period in 2014, but both companies were caught out by the severe winter weather in 2013. The bad weather disrupted their networks and created demand bottlenecks because of a combination of customers who were unable to visit shops and retailers that were offering last-minute online promotions.
In truth, dealing with peak is as much about the timing of peak days in demand as it is about their magnitude. FedEx's management believes that its separate ground and air networks help give it more flexibility in dealing with peak periods. However, FedEx is still having to invest more and more each year in hiring seasonal workers to meet peak demand.
For example, FedEx hired 40,000 extra seasonal workers in 2013, only to increase the figure to 50,000 in 2014, and on the recent first-quarter earnings call, CEO of FedEx Services Mike Glenn disclosed that the company will "add more than 55,000 seasonal positions throughout the network that help the holidays arrive this year."
Glenn's responses to analysts' questions would go on to show how difficult dealing with peak demand is becoming. For example, Glenn agreed that "many retailers" were being creative over promotional activities and argued:
That's why it's more difficult to actually forecast what the peak day is going to be. It was fairly predictable in years past. I think based upon our experience last year, it's certainly more challenging in that regard.
He also discussed the necessity of putting "some caps in places we have to do every year."
It's clear from Glenn's commentary that FedEx is actively preparing for peak, but precise predictions on the timing of peak demand are becoming increasingly harder to make.
UPS Access Points will help the company deal with peak demand in 2015. Image source: UPS.
United Parcel Service: Too little, too much
The last point hits home when looking at the difficulties that UPS has had in the past two years. In 2014, the company was forced to reduce earnings estimates as a consequence of the extra investment needed to create capacity to meet demand. Essentially, UPS had faced up to widespread criticism following its difficulties in the 2013 holiday period and was forced to invest to ensure customer satisfaction.
The result? The company missed earnings estimates in the winter of 2014, as it discovered it had invested too much on capacity on certain days during peak demand. In other words, just as FedEx's Glenn alluded to, it's becoming difficult to predict the exact timing and shape of peak demand across a period lasting only a few days.
UPS' immediate response to missing estimates in January 2015 was to plan to reduce operating costs and implement new pricing strategies designed to help smooth out demand during peak season. Later in July, a UPS spokesman was quoted, in a Bloomberg article, as saying that the company expected to hire fewer than the 95,000 seasonal workers hired last year -- implying a reduction in operating costs. However, in September the company issued a press release claiming that 90,000 to 95,000 seasonal workers would be hired. In other words, it appears that UPS is being forced into hiring a similar level of seasonal workers as it did last year.
Meanwhile, on UPS' second-quarter earnings call, CFO Alan Gershenhorn outlined the "comprehensive peak pricing initiatives under way to increase revenue from the customers that surge and ultimately drive significantly greater cost at peak" and disclosed that they were "separate and distinct from our year-round revenue management and solutioning."
Simply put, UPS is using pricing as a strategy to help smooth out peak demand so the company can better manage its operating costs during the period.
What does it mean for investors?
All told, there is no getting away from the fact that the peak demand period has become a lot harder to predict, and therefore the risk in both stocks has gone up. The structure of demand in the holiday season will ultimately be led by the consumer, but both companies are actively engaging with retailers to better manage consumer behavior.
In a nutshell, short-term investors may be tempted to take a cautious view on buying the stock until they know how the holiday period pans out for FedEx and UPS, as both companies are being forced to hire significant numbers of seasonal workers. However, in the long term, burgeoning e-commerce demand offers significant upside as well. Just don't expect every holiday season to go smoothly.
