UPS vs. FedEx

Which shipping company is right about the economy?

Coke and Pepsi, McDonald’s and Burger King, Boeing and Airbus—this is an economy full of duopolies. One of those pairs, UPS and FedEx, is proving to be a fascinating Rorschach test about the state of the economy.

UPS and FedEx both make excellent bellwethers for the stock market as well as the economy at large. They have their fingers on the pulse of trade and services. When the economy is humming, these firms process ever-larger quantities of parcels, envelopes, and boxes. FedEx and UPS are also heavily exposed to price changes in key inputs—particularly transportation and fuel. So, their results can tell us quite a lot about how rising costs affect corporate profits, and thus stock prices.

But UPS and FedEx are sending mixed messages. UPS reported its earnings for the quarter that ended in June earlier this week. On the surface, things looked good. Overall revenues rose 15 percent, and small-package volume rose 6 percent. But the bottom line wasn’t as impressive as the top line. As this more detailed release shows, profit margins fell from 15.2 percent to 14.4 percent. In other words, expenses rose more rapidly than revenues, which meant the profits came in nearly 10 percent lower than Wall Street analysts had expected. The reason: The company had to spend a lot more on fuel and transportation costs. What’s more, UPS had capped fuel surcharges in April and May to insulate consumers from the rising prices (the caps have since been removed). UPS CFO Scott Davis also cited higher costs on health care and rail freight, which it was also unable to pass on to consumers.

Davis said next year’s profits would come in at the low end of expectations, too. And when an analyst asked about the economy, Davis replied: “I think there are a lot of signs out there that indicate that we’re going to moderate,” hastening to add, “I’m not saying we’re going to head into a recession or anything like that.”

Analysts from big investment banks downgraded UPS stock, which has lost about 13 percent of its value this week, as this five-day chart shows. Why was the UPS news so bad? Shrinking margins plus slowing economy equals stock market meltdown. When a company runs into economic or competitive headwinds at a time when costs are rising, it loses pricing power. It has to offer incentives or absorb higher costs rather than pass them on to consumers. And as a result, margins shrink. And when you add a slowing economy to the mix, it magnifies the fear of future problems.

FedEx’s stock initially fell in sympathy with UPS, but it has weathered the storm better. Why? About a month ago, FedEx told a very different story—about the economy, and about its ability to deal with high fuel prices. On June 21, FedEx reported its results for the quarter that ended May 31. Profits rose 25 percent. Instead of shrinking, FedEx’s margins grew smartly, from 9.6 percent to 10.9 percent. Instead of eating higher fuel and transportation costs, FedEx was able to pass them on to customers via fuel surcharges and higher prices. Margins in the FedEx Express business, which accounts for about two-thirds of the company’s revenues, rose from 8.4 percent to 10 percent. In other words, its core business was about 20 percent more profitable than it was in the year-ago quarter.

And when it came to the economy and FedEx’s future profits, Chairman Fred Smith saw nothing but green lights. “We remain optimistic about the global economic environment for fiscal 2007 and our ability to effectively manage our business,” he said. FedEx projected that its earnings would grow between 6 percent and 10 percent next year.

So, who’s right? All things being equal, FedEx and UPS should see their volumes and ability to profit moving in the same direction. But all things aren’t always equal. The two shipping companies have a different business composition: FedEx gets most of its revenues from express delivery and has a small retail copying unit (Kinko’s); UPS has a larger presence in the global freight market. It could be that the sectors and customers that use FedEx are doing better than the sectors and customers that use UPS, or that FedEx is simply doing a better job managing its business and is taking market share from UPS.

Timing may also have something to do with it. FedEx reported its results a month earlier than UPS did. And while the economy doesn’t stop on a dime, things can change in the matter of a few weeks. This week alone, all sorts of data have emerged that lead one to think that higher interest rates, higher energy costs, and consumer exhaustion have combined to put the brakes on the American economic engine. Just look at today’s report on gross domestic product, which shows that the rate of economic growth fell by about half in the second quarter, or the slowdown in June sales of new homes and of existing homes sales, or the results of restaurant chains like Applebee’s, which reported declining guest traffic in both June and July.

More likely, it’s a combination. The macroeconomic environment is growing more unfriendly to the profit margins of large companies, and FedEx seems to be managing through the challenge better than UPS. A rising tide lifts all boats. But when the tide starts to recede, only expert helmsmen avoid the rocks.