What Does the UPS Earnings Beat Mean for FedEx?

7/30/15

By Adam Levine-Weinberg, MotleyFool

Package delivery giant United Parcel Service (NYSE:UPS) reported solid second-quarter earnings per share on Tuesday, beating Wall Street estimates. The company also forecast that its full-year EPS would be near the high end of its guidance range. Investors liked the news, driving the stock higher even though UPS missed analysts' revenue expectations.

UPS Price Chart

UPS VS. FEDEX STOCK PERFORMANCE. DATA BY YCHARTS.

Shares of top UPS rival FedEx (NYSE:FDX) also climbed higher after the UPS results. But how did UPS's results and guidance impact the business outlook for FedEx?

U.S. growth slowsOn the domestic front, UPS didn't actually sound very bullish. On the company's earnings call, UPS CEO David Abney noted that the consensus forecast for 2015 U.S. GDP growth has fallen from 3.1% to 2.3% since the beginning of the year. Other economic indicators such as retail sales have also been mixed.

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THE DOMESTIC BUSINESS WASN'T UPS'S MAIN PROFIT GROWTH DRIVER LAST QUARTER.

At UPS specifically, total daily deliveries rose just 1.8% year over year for the U.S. domestic package segment. UPS blamed slower business-to-consumer (i.e., e-commerce) growth. As a result of these macro factors and company-specific trends, UPS is taking a cautious view of U.S. growth.

Profit growth came from international marketsIndeed, operating profit rose just 3% in the U.S. domestic package segment last quarter. The upside in UPS's results instead came from outside the U.S.

More than half of the growth in Q2 adjusted operating profit at UPS came from the international package segment. While revenue declined 6.4% year over year in the segment, it would have been up by 1.5% absent currency effects related to the strong dollar. Lower fuel surcharges had an additional 350 basis point negative impact.

The bottom line is that despite economic weakness in a number of countries, global trade is growing. Intra-Europe shipments rose 8.5% for UPS last quarter. The strong dollar and weak euro have hurt U.S. exports but are boosting import demand in the U.S. European luxury goods companies have also seen good growth in Asia, helped by the weak euro.

FedEx's TNT acquisition looks goodThe UPS earnings report has mixed messages for FedEx investors. On one hand, the UPS earnings beat was mainly driven by cost cutting. Domestic revenue growth was sluggish, with the outlook also subpar. In other words, the domestic demand environment doesn't seem good enough to drive strong earnings growth at FedEx. Of course, FedEx has its own big cost-cutting program, but investors have known about that for years.

On the other hand, UPS is seeing improved international demand, with Europe appearing to be an area of particular strength. The euro has fallen nearly 20% against the dollar in the past year, and it appears that this is starting to stimulate export growth (as it should, in theory).

Shipping Fedex Express Truck Fdx

FEDEX IS LOOKING TO EXPAND IN EUROPE BY ACQUIRING TNT EXPRESS.

This makes FedEx's $4.9 billion bid for struggling Dutch rival TNT Express look like a smart move. The purpose of this acquisition -- which still awaits regulatory approval -- is to expand FedEx's road network in Europe to compete better with rivals like UPS and DHL there.

TNT is working on its own turnaround plan right now. It recently reported decent second-quarter results, but it is still far from being a healthy business. Merging with FedEx should unlock some synergies to improve its profitability. But demand growth is what's really needed for FedEx to get a lot of value from this merger.

UPS's earnings report shows that shipment volume growth may finally be strengthening in Europe. If that trend continues, it bodes well for FedEx's profit growth over the next few years, assuming it can complete the acquisition of TNT Express.

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