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September 28, 2020

MRP Adds Long Package Delivery as a Theme

Summary: The coronavirus pandemic has been a game-changer for package delivery companies. An accelerated shift towards ecommerce has led to elevated package carrier volumes; Meanwhile, a dramatic reduction in air cargo capacity has given carriers the strongest pricing power they’ve been able to command in years. These two factors and other favorable conditions should enable the sector to embark on a long period of margin expansion, which is why MRP is adding Long Package Carriers as a new theme.


Related Stocks: FedEx Corporation (FDX), United Parcel Service (UPS),
 Deutsche Post DHL (DPW.DE)

The package delivery industry faced structural headwinds heading into 2020. Then the coronavirus pandemic came along, reversing the fortunes of major carriers such as FedEx Corporation (FDX), United Parcel Service (UPS), and Deutsche Post DHL also known as Deutsche Post AG (DPW.DE).  


As noted in MRP’s August 17 report titled FedEx & UPS Goldilocks Moment is Far from Over, a stronger shift towards ecommerce, combined with historically low fuel prices, and the grounding of most commercial jets worldwide have created a goldilocks moment for parcel expeditors.


Accelerated Shift Towards Ecommerce Worldwide


Fedex and UPS have seen huge spikes in package volume since the COVID-19 pandemic began. DHL’s volumes also reached peak season levels as people shifted their purchases of nutraceuticals, health and beauty care, apparel, pharmaceuticals and home office supplies online. Although business-to-business (B2B) shipments plunged for all three transportation companies, home deliveries soared enough to make up the shortfall. 


Ecommerce as a percentage of total retail stood at 21% in the second quarter of 2020, up from 15% a year earlier, and activity remains elevated. In July, for example, UPS’ volumes grew 26% compared with average monthly growth of 23% in the April-to-June period. FedEx too saw its volumes rise 22% compared with 19% growth, on average, in the first three full months of the coronavirus pandemic. Delivery of online purchases as well as product returns and exchanges by consumers account for part of the volume surge.


On FedEx’ September 15 earning call, one executive expressed the following: “Pre-COVID, we projected that the U.S. domestic market would hit 100 million packages per day by calendar year 2026. We now project that the U.S. domestic parcel market will hit this mark by calendar year 2023, pulling volume projections forward by 3 years from the previous expectation.


Politics has delivered yet another boon for the group recently. Ecommerce giant eBay, which ships hundreds of millions of items to buyers’ doorsteps each year, just announced that it is shifting a portion of its delivery volume from the United States Postal Service (USPS) to UPS because of reliability issues at the agency. 


Vaccine Distribution Will Provide Another Boost


What's more, the major package delivery companies are gearing up to ship COVID-19 vaccines and other pharmaceutical goods to governments and hospitals around the world once those become available. About 10 billion doses of vaccines are expected to be delivered globally, and the  size and breadth of the carriers’ networks, as well as their shipping and cold chain capabilities, position them to become the primary transportation networks for this massive endeavor.


According to Reuters, UPS is also preparing to launch a new service that dispatches nurses to vaccinate adults in their homes as a way to get a larger slice of the $85 billion outsourced healthcare logistics markets. DHL currently dominates that market, which is expected to grow to $105 billion by 2021.


Improving Profit Margins


In the meantime, the increased demand for parcel shipments amid a dramatic reduction in air cargo capacity has shifted pricing power from shippers (i.e. retailers) to carriers. As result, UPS and FedEx were able to hit some large shippers with price increases in the double-digit percent range this summer. Some of the increases were implemented mid-contract, while other increases were rolled out during contract renewals.


The carriers are also benefitting from the lowest fuel costs seen in years. While fuel prices have rebounded from their April lows, they are still below pre-pandemic levels. Jet fuel’s current U.S. spot price of $0.99 per gallon is 44% lower than at the start of the year. Likewise, gasoline’s current price of $1.21 per gallon is 27% lower than in January.


Thanks to the spike in freight rates and lower fuel costs, the carriers are achieving sequential growth in their operating margins. The gradual recovery of business-to-business (B2B) volumes will help margins further, as B2B deliveries tend to be more profitable than those to homes.


Blow-Out Earnings Should Continue 


The favorable environment has led to blow out earnings for this segment of the transportation industry. FedEx reported adjusted earnings of $4.87 per share for the three months ending in August, the group's fiscal first quarter. That’s up 60% from the same period last year and 80% above consensus expectations. In its last earnings call on July 30, UPS reported adjusted earnings of $2.13 per share, nearly double consensus of $1.07


Earnings should stay strong in the quarters ahead. eMarketer forecasts that the third quarter will be the all-time peak for e-commerce with about 23% of all retail purchases being made online. DHL eCommerce Solutions, a division focused entirely on servicing B2C online merchants, expects 30-50% more ecommerce volumes this holiday peak season compared to last season. 


Meanwhile, shipping demand continues to outstrip capacity as reflected by the elevated level of the DHL Supply Chain Pricing Power Index.


Wall Street Turns Bullish


Not surprisingly, the earnings beats have set the carriers’ share prices on fire. FedEx shares are up 62% year-to-date, while those of UPS and DHL have risen 37% and 12%, respectively. Almost all of the gains occurred in the past three months.

Despite the strong share price run-up in such a short period, a chorus of Wall Street analysts are saying it isn’t too late to jump on the bandwagon.


Credit Suisse has turned bullish on UPS for the first time in years, and recently upgraded the stock to outperform from neutral. Stifel analyst David Ross has also upgraded FDX to the equivalent of buy from hold and raised his price target for the stock to $281 from $175. ″It’s possible that we’re at the front end of a multi-year pricing cycle in parcel that could be transformative to both FedEx and UPS. If we are, there is a reasonable bull-case in which FedEx’s share price can double to $500,” said Citi analyst Christian Wetherbee in a note to clients earlier this month.

THEME ALERT

New MRP Theme: Long Package Carriers


2020 has been a big year for package delivery companies, and their good fortune is bound to continue due to four factors:

  • Greater e-commerce adoption by the world 
  • Future shipment of billions of doses of COVID vaccines worldwide
  • Expansion of carriers’ transportation networks
  • Improved margins thanks to strong pricing power, low fuel costs, and eventual recovery of B2B business which tends to be more profitable than B2C

MRP expects these tailwinds to persist through 2021. As such, we are adding Long Package Carriers as a new MRP theme effective today. MRP will monitor the theme through a basket comprised of three stocks: FedEx (FDX), United Parcel Service (UPS) and Deutsche Post DHL (DPW.DE).

Package Carriers vs Transportation Sector vs S&P 500