The Online Retail Revolution Part III: Buying The Shipping Giants

| About: United Parcel (UPS)

Summary

On the backside of a recent market slide, UPS and FedEx are trading near 52-week lows despite the strongest e-commerce holiday season in history.

FedEx and UPS are struggling to grow at the rate of the e-commerce sector in the near term, potentially setting up market price volatility that can be exploited by patient investors.

Several purchasing strategies are outlined.

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In Part I of this series, I discussed the rapidly changing landscape of the retail sector and the rapid growth of e-commerce at the expense of brick-and-mortar retailers. My conclusion was that investments in United Parcel Service (NYSE:UPS) and FedEx Corporation (NYSE:FDX) were ways to capture the growth in e-commerce with less risk than investing in online retailers directly, as the two shipping behemoths would be direct beneficiaries of the trend.

In Part II of this series, I used several metrics to place valuations on both UPS and FedEx in an attempt to determine which company is a better value for investors. The results came back mixed; both companies had their pros and cons, and both appeared to be undervalued with an edge to FedEx Corporation.

The 2015 Christmas season is over, and as I predicted in my first article, it was a whopper for online retailers, smashing e-commerce records. Cyber Monday revenues eclipsed the $3B mark, setting a new all-time record, up 16% from last year. Over the five-day period beginning on Thanksgiving, total revenues were $11.11B, up 17% from a year ago. Data from trackers ShopperTrak and RetailNext, on the other hand, estimated in-store purchases were down an estimated 10.4% and 4.7%, respectively, over the Black Friday weekend.

It comes as little shock that Amazon (NASDAQ:AMZN) was the big winner this holiday season, adding over 3 million Prime members in the third week of December alone, doubling last year's record-setting shopping season for Amazon devices, seeing over 200 million more items shipped for free with Prime this holiday than last, and Prime members doubling their viewing hours of Prime Video YoY.

As a result, UPS and FedEx could hardly keep up, with plenty of complaints coming in from angry patrons claiming their packages did not arrive on time. While both shippers had their issues, UPS outperformed FedEx during the holidays - something I expected considering it is a more mature company with superior fleet integration, as highlighted in Part II of this series. Both shippers began the holiday season strong, but bad weather conditions in parts of the US slowed delivery through the networks two days before Christmas.

For FedEx, only 77% of overnight service packages were delivered on time December 23rd, compared with 95.2% on December 21st. For UPS, only 79.5% of overnight packages made it on time on December 23rd, compared with 94% on December 21st. By Christmas Eve, both carriers had recovered, with on-time performance rates of 96.2% for FedEx and 97.7% percent for UPS.

Perhaps these on-time delivery rates seem low, but let's put the numbers into context. Approximately 60 million packages were delivered on Christmas Eve alone between UPS, FedEx and the USPS - that's a 70% increase over average daily volume. Even with a 99% on-time delivery rate, that would leave about 600,000 packages delivered late. It is clear that e-commerce is growing at such a rapid rate, shippers cannot grow as quickly.

The growth rate is so explosive that one can argue UPS and FedEx are transcending being competitors - there is so much available growth within the industry that UPS and FedEx can each have ever-increasing pieces of the pie without stepping on each other's toes, because neither of them are threatening the other's market share. They no longer need to compete directly.

Given this alarming change in the marketplace, considering both companies appear to be undervalued based on prior research, it begs the question: "Why not own both?"

Sustainability Of Growth

There has been much talk recently about Amazon attempting to start up its own fleet for deliveries. This does not concern me for the following reasons:

  1. Logistics businesses are very costly to start up and maintain. As a man who works for a company with a fleet of over 200 vehicles, I can attest that commercial driving operations are very high-risk. You are entrusting strangers to drive very expensive pieces of heavy equipment. You can do your best to screen them, but you do not know the condition of every driver every day - all it takes is one driver to come in without their head in the game to cause an incident. Maybe they are drunk, high or hung over from the day before. Maybe the driver is upset from an argument with their spouse. Maybe they have a sick friend or a recent death in the family and they're distracted. Maybe they just love texting while driving. The insurance costs are huge, maintenance costs constant, fuel prices highly volatile, personnel unpredictable - and on top of all that, you are cruising the streets with a company name painted on your vehicle that screams BIG INSURANCE POLICY to a public eager for someone with deep pockets to sue in the event of an accident.

    I do not see Amazon, a company that is barely profitable today and typically NOT profitable historically, being able to build a serious fleet anytime soon. The company is likely not going to be able to do much more than bridge the gap between the shortcomings of UPS and FedEx - whose partnerships they NEED more than any other company - for the foreseeable future.

  2. UPS and FedEx have shown they cannot grow at a rate as fast as the e-commerce sector as a whole. No growth is a problem for companies, but overly rapid growth can be even more dangerous. It takes tons of capital to expand UPS and FedEx's operations, and I believe if Amazon can take some of the pressure off UPS and FedEx's growth rates, it could do a lot of good for the shippers. Controlled, constant growth is better than out-of-control growth.
  3. Amazon is not the only player in e-commerce. Even if the company went away completely - and it likely never will for the shippers - the entire sector is exploding so quickly that the revenues could be made up elsewhere in time. eBay (NASDAQ:EBAY), Wal-Mart (NYSE:WMT), Target (NYSE:TGT) or Best Buy (NYSE:BBY), anyone?

Ownership Strategies - Direct Stock Purchase Plan

For those of you who have read my articles before, you're likely aware I am a huge fan of Direct Stock Purchase Plans [DSPPs] and Dividend Re-investment Plans [DRIPs], which use the strategy of dollar-cost averaging via automated monthly buy-ins to accumulate a position over time. Both UPS and FedEx offer Direct Stock Purchase Plans through Computershare, which means you do not need to be a prior shareholder of record to open an account with either company.

The fee schedules are below:

UNITED PARCEL SERVICE, INC. (click here for plan details)
New Account Investment Options:
a) Minimum one-time purchase OR $250.00
b) Minimum ongoing automatic investment $100.00
Requires 100 per transaction for at least 3 consecutive transactions
Existing Account Investment Options:
a) Minimum purchase OR $100.00
b) Minimum ongoing automatic investment $100.00
Minimum shares required to enroll for existing accounts 1
Maximum Purchase $120,000.00 Per Year.
PLAN FEES
Initial Setup Fee $15.00
Cash Purchase Fee $5.00
Ongoing Automatic Investment Fee $2.00
Purchase Processing Fee (per share) $0.12
Dividend Reinvestment Fee 5% of amount reinvested up to a maximum of $5.00
Batch Sale Fee $15.00
Batch Sale Processing Fee (per share) $0.12
Batch Maximum Sales Fee N/A
Market Order Sale Fee $25.00
Market Order Processing Fee (per share) $0.12
Market Order Maximum Sales Fee N/A
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FEDEX CORPORATION (click here for plan details)
New Account Investment Options:
a) Minimum one-time purchase OR $1,000.00
b) Minimum ongoing automatic investment $50.00
Requires a minimum of $50 per transaction for at least 20 consecutive transactions
Existing Account Investment Options:
a) Minimum purchase OR $100.00
b) Minimum ongoing automatic investment $50.00
Minimum shares required to enroll for existing accounts 1
Maximum Purchase $250,000.00 Per Year.
PLAN FEES
Initial Setup Fee $10.00
Cash Purchase Fee $5.00
Ongoing Automatic Investment Fee $2.00
Purchase Processing Fee (per share) $0.03
Dividend Reinvestment Fee 5% of amount reinvested up to a maximum of $3.00
Batch Sale Fee $15.00
Batch Sale Processing Fee (per share) $0.09
Batch Maximum Sales Fee N/A
Market Order Sale Fee $25.00
Market Order Processing Fee (per share) $0.09
Market Order Maximum Sales Fee N/A
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The fee schedules are about average for what you can expect from a Direct Stock Purchase Plan - they are far from free, but I have also seen much worse.

In order to keep plan costs at 1% or less, a person would have to commit at least $205/month with FedEx and $230/month with UPS with share prices being what they are currently. If a person were to enroll in both plans at these contribution rates, and market prices stayed flat over the year, that person would wind up committing total capital of $5,220 over the course of the year, while paying about $52/year in fees, excluding the one-time initial setup fee. Market price appreciation would reduce fees, since a per-share charge is present on these plans, while a drop in market price would increase total fee costs. Overall, this is less than most of us spend in one month for a mobile phone.

Disclaimer: DSPPs and DRIPs do not allow the immediate purchase or sale of stock. Placing a market order can take several days, sometimes more than a week, to execute. These plans have low liquidity and are meant to be long-term holdings, preferably generational holdings. Open these plans only if you intend to be a long-term shareholder, preferably a lifetime shareholder.

I feel the DSPP strategy affords the investor the best way to minimize risk. FedEx and UPS are going through big changes to accommodate the growing marketplace, and growing pains - i.e. stock price volatility - can be expected moving forward until the market stabilizes. I expect earnings to be erratic for both companies in this environment, with both huge wins and big misses in the future, and dollar-cost averaging is the best tool I know to help mitigate these risks.

Ownership Strategies - Cash-Covered Puts

Another potentially great option for purchasing stock in these two companies is through the Cash-Covered Put Option strategy. This strategy is not as forgiving as a DSPP, because it will require the individual investor to assign a valuation to the company that they are comfortable with. These are the basic steps of the Covered Put strategy via example:

  1. Browse the PUT contracts available to see if you can find a price for the stock that you are willing to pay. PUT contracts are sold at a price below current market value.


    Currently, UPS is trading at $91.39/share and FedEx is trading at $134.71/share.

    Let's assume a UPS contract is offered at $87/share and a FedEx contract is offered at $127/share, and that both expire in 90 days.

  2. Purchase a contract - one contract is typically 100 shares of stock. You do not own the stock yet. You must maintain the cash balance in your account at all times to cover the sale in the event that the stock is PUT onto you.

    So, you will need to keep:


    100*$88 = $8,800 total cash reserves for UPS
    100*$127 = $12,700 total cash reserves for FedEx

    You must maintain a $21,500 cash balance in your account to hold both contracts. If you do not, your broker has the right to enter your account and sell your other holdings as needed to come up with the cash if your contracts are exercised.

  3. You keep the premium, no matter what. The "premium" is the spread between market price and your contract.

    100*($91.39-$88) = $339 premium for UPS
    100*($134.71-$127) = $771 premium for FedEx

    Congratulations! You just received a $1,110 bonus for taking out the two contracts. You keep that cash no matter what.

  4. Possibility #1: If the stock price for UPS falls below $88 and the stock price for FedEx falls below $127, you may have the contracts PUT on you, meaning you are obligated to buy 100 shares of each company at the strike prices of $88 and $127, respectively. The $21,500 is withdrawn from your account, and you now own 100 shares of UPS and 100 shares of FedEx - but that's totally cool because you wanted to own them anyway, you got a buy-in below the original market price of $91.39 and $134.71, and you made a $1,110 premium, which further reduces your purchase costs.
  5. Possibility #2: The stock prices never fall below $88/share and $127/share in the 90-day window, and the contracts expire worthless. You don't own any FedEx and UPS stock, but you kept the $1,110 for doing absolutely nothing! If you still want to own UPS and FedEx at current market prices, repeat the process all over again.

WARNING: I am not an options trader. I have never traded options, and this is the system as I understand it. For detailed knowledge of options trading, I suggest you read this article and memorize its contents as written by the esteemed Mr. Richard Berger. I am an electrical engineer by trade, not an investment advisor.

Ownership Strategies - Market and Limit Orders

There's no rocket science here. UPS and FedEx are both down at their 52-week lows. Think that's a great price? Place a market order.

Think it's a little too high? Commit some capital to your portfolio and set a limit order at a lower price. If it hits, it hits.

Conclusion

I firmly believe UPS and FedEx are poised to capitalize big time from the rapidly accelerating growth in e-commerce, but the road to riches will have many bumps along the way. These companies will need to carefully manage their growth moving forward, and scaling two already big companies into even bigger companies is no small task.

I hope you have enjoyed this three-part series. As always, happy investing.

Disclosure: I am/we are long UPS, FDX.

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: All information found herein, including any ideas, opinions, views, predictions, commentaries, forecasts, suggestions or stock picks, expressed or implied, are for informational, entertainment or educational purposes only and should not be construed as personal investment advice. I am not a licensed investment adviser.