The Pricing Power Tell

Nov.27.13 | About: United Parcel (UPS)

I've once compared UPS (NYSE:UPS) and FedEx (NYSE:FDX) to the railroads, and online retailers to the coal miners. This comparison stemmed from the fact that while there are thousands of online retailers, all of them have to ship their wares through a very limited set of shippers. Much like there are many coal mines, but for each there is usually a single railroad, which can take its product to the market.

This lopsided situation gives the shipping oligopoly a massively superior bargaining position. It ensures that the economics of the shippers will be decent over time and will allow them to capture most of the value created by online retailing. The one exception is the other oligopoly - paying processors, which mostly includes Visa, MasterCard, American Express and increasingly, PayPal.

While conceptually the above thesis - that shippers will capture the value - is easy to understand, one could ask more specifically where the proof is of that happening. Just this week, UPS again provided us with the answer: The proof is in the pricing power.

Pricing power, or price elasticity of demand, tells us how much a company can increase prices while still maintaining sales volume. This is an easy concept to absorb. If Amazon.com (NASDAQ:AMZN) increases the price on any of the products it sells, the sales plunge. Amazon.com has seen it happen on very minor moves, for instance the Kindle Fire HDX is selling poorly in 2013 because it's priced slightly higher ($229) than the Kindle Fire HD was the previous year ($199), even though it's a superior product. UPS and FedEx, on the other hand, increase prices regularly and yet see no volume implosion. That's pricing power.

This is what the price increases have looked like over the last 8 years at UPS (Source: BofA Merrill Lynch):

And obviously, it's not just UPS. FedEx and DHL Express matched the increases. This is what pricing power looks like. Contrast it with the online retailers always in the cut-throat business of having to have the lowest possible price. Over time, this pricing power assures that the shipping business is a much superior business for investors.

The one threat

There is basically one threat to UPS and FedEx in what concerns pricing power. That threat is the fact that both face an uneconomic player, USPS, also delivering packages. USPS is able to run at a deep deficit and stay afloat, and that puts downward pressure on what UPS and FedEx can charge to deliver the same thing. While UPS and FedEx have convenience advantages, there is only so much premium both can charge before customers start shifting volume towards USPS - much like Amazon.com is already doing where it can though implying a customer service penalty.

Conclusion

Each year that passes, the shippers reinforce the very obvious fact that if there's value to be captured in online retail, it will be captured by them (and the payment processors). This fact is illustrated in the massive pricing power the shippers have, where they increase prices consistently year after year without losing volume.

The shippers are an obvious choice to buy in any economic slowdown, as their activity would be temporarily impacted yet their superior market position would probably remain the same.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I have an options position in AMZN, which stands to gain from a drop in the stock.