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Will UPS Be Next to Deliver a Warning?

Will UPS Be Next to Deliver a Warning?

FedEx Corporation (NYSE: FDX) sent shockwaves through the stock market by posting a big earnings miss and removing guidance due to “worsened” economic conditions. On the heels of a weak August retail sales report, the warning signaled that the U.S. economy (and potentially stocks) could be in for a tough winter.

While the 33% EPS miss was a shocker, in some ways we should've seen it coming. Online shopping behaviors have been moderating for some time now as weary shoppers return to physical stores and press the ‘add to cart’ button with less fervor than during the pandemic. Businesses have taken a cautious stance on spending in 2022 and, as a result, magnified the slowdown in consumer demand. Finally, cost inflation has compounded FedEx’s woes—most notably, fuel expenses.

Since FedEx is considered a bellwether of economic activity, the ripple effects of the warning go well beyond the transportation sector. E-commerce aside, it suggests inflation is having a deeper impact on consumer and business confidence. Surging interest rates designed to tame said inflation could make matters worse, allowing fewer Americans to secure mortgages, auto loans, and pay down credit card debt.

Is There a Silver Lining for the Transportation Industry? 

It may not be all doom and gloom. FedEx rival United Parcel Service, Inc. (NYSE: UPS) painted a less bleak picture when it reported Q2 results. The company managed to top Wall Street earnings estimates and deliver 8% year-over-year profit growth. The FedEx bottom line represented a 21% decline.

Better yet, UPS reaffirmed its 2022 guidance and tripled its share repurchase program target to $3 billion. The dividend was also increased by 49%, which has given Big Brown a sizable forward yield edge over FedEx (3.8% versus 3.2%). 

Will the real shipping and logistics bellwether please stand up?

To be fair, the UPS results covered the three-month period that ended June 30th. FedEx’s fiscal Q1 bombshell extended into August end performance. So when UPS reported, the macro outlook may not have been so dire. Which begs the question…

Will UPS Be Issuing a FedEx-Like Warning? 

The contrast in tone between the UPS and FedEx updates could very well get reconciled in the weeks ahead. Since it faces the same demand and cost pressures as FedEx, it would be surprising if UPS didn’t dampen its enthusiasm for future growth before or during its October 25th report. 

A less desirable scenario for UPS shareholders would be if UPS management lowers its growth forecasts or backpedals on its buyback ambitions. This summer UPS projected $102 billion in 2022 revenue, which would represent about 6% growth compared to 2021. 

Coincidentally, this came on the eve of the Fed’s July rate hike that was followed by this month's duplicate 0.75% hike. This suggests that economic uncertainty has since been elevated and that upcoming UPS announcements may not be delivered with such optimism.

One thing UPS has going for it that FedEx does not is a new CEO that has injected life into the company. Former Home Depot CFO Carol Tome took over the leadership reins last year and has received early praise for navigating UPS through the current economic climate.  This has kept the company’s EPS beat streak alive at eight quarters.

Whether the new leadership team can continue to exceed expectations rests largely in the hands of U.S. consumers. The degree to which people choose to spend this holiday shopping season will likely have a profound impact on UPS’ performance, not to mention the market’s view of consumer health. Meanwhile, the recent escalation of the Russia-Ukraine war threatens to reignite energy prices just as they calmed down.

Is FedEx or UPS the Better Stock to Own?

Investors willing to take a chance on the downturn in shipping stocks have a tough choice between the industry leaders. From a valuation perspective, FedEx appears to be the better bargain. It trades at roughly 11x trailing earnings compared to 13x for UPS. For the income-oriented investor, however, UPS’s dividend yield edge may make the P/E ratio difference negligible. 

The reality is that despite the stark differences in their recent market updates, FedEx and UPS are in the same boat. Future insights from one or the other are likely to move both stocks in the same direction. We saw the effect on UPS and other industry peers when the FedEx news broke. 

Interestingly though, the historic correlation between the stocks isn’t as high as one may expect. Using monthly returns over the last five years, the correlation between FedEx and UPS is only 0.67. Moreover, FedEx, perhaps due to its increasing international exposure, has been the more volatile name in that stretch.

What’s as surprising as the lack of UPS warning to date is that Wall Street hasn’t budged from its opinions since the FedEx announcement. On Monday, Morgan Stanley became the 13th straight firm to reiterate its FedEx rating. In a mix of holds and buys (no sells), the analyst did however offer the bleakest price target yet at $125. Similarly, no UPS rating changes have occurred since the FedEx warning.

Things have been eerily quiet on the UPS front since FedEx took one for the team. Whether there is another shoe to drop or more surprising optimism remains to be seen, but it’s hard to imagine this key economic story won’t be a package deal.

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