Advertisement

This analyst says UPS is a buy ahead of the holiday season

Stifel has upgraded UPS ahead of peak shipping season. Stifel Transportation & Logistics Analyst Bruce Chan joins Yahoo Finance Live to discuss.

Video Transcript

- Welcome back to "Yahoo Finance Live". We are watching a lot of the names in the shipping sector as, of course, we've been highlighting some trouble there when you think about how COVID has impacted everything, anything you want to ship in today's day and age. And UPS has seen a nice pop here today, after Stifel upgraded the stock, about a 4% pop here, as analysts there point to a potential 20% upside, despite all of the issues right now in the shipping space, saying that UPS is in a position with their disciplined capital allocation strategy to perhaps capitalize on all the opportunities there.

For more on that, I want to bring on the analyst behind the report. Bruce Chan is Stifel Transportation and Logistics Analyst. He joins us now. And Bruce, when we look at the opportunity there, 20% upside, walk me through what UPS is really best poised to capitalize on. As we know, it's been a challenging year for a lot of these companies.

BRUCE CHAN: Yeah, thanks Zach. I appreciate you having me on here. So I think you said it. Right now, it's a challenge for anybody that's shipping goods. But if you have capacity, if you have service, if you have an ability to try to correct some of the supply chain imbalances that we're seeing right now, we think there is a good chance to benefit.

So when we talk about the upgrade, it's really been premised on some of the conversations that we've been having with investors over the past couple of weeks. There's been a lot of focus on, I think, some of the ground volume comp issues that we're seeing against very strong last year. And then also a lot of talk about the labor cost pressures, which we heard about on FedEx's Q1 earnings a few weeks ago.

But we think that some of these concerns are misplaced, at least to the extent that the stock has traded off in recent weeks, because we've got a really strong yield backdrop right now, despite what's going on with the volume comps. We've got a strong fundamental growth story for e-commerce here. Obviously, a lot of supply chain pressures driving activity in the industry.

And finally, we think UPS is not subject to the same types of pressures that FedEx is right now. So to the extent that you saw that sympathetic trade off, we think it's a little bit overdone. And investors should have a good opportunity to own a very high-quality company here.

AKIKO FUJITA: Yeah, Bruce, I don't think anybody would argue that volume is an issue right now when we're talking about so much needing to be processed because of the backlog we're seeing across the board with logistics companies. My question is really whether, in fact, UPS is best positioned to meet that kind of demand. If you think about some of its rivals, everybody sort of in the same position. How do you think things set up for UPS going into the holiday season?

BRUCE CHAN: Yeah, that's a great point, Akiko. And I'd say that UPS is in the best position, or at least one of the best positions. And there are a myriad of reasons, but I'll name a couple.

So first, when you're looking at the kind of supply chain disruptions and backlogs as we are right now, there are a lot of shippers out there that really need to move product, and they need to move it right away. And the way you do that is through high-speed, high-service networks, which, of course, UPS is one. FedEx happens to be one, as well.

But the big shippers out there, I think if they're trying to get products on store shelves before the holiday season, they're probably not looking to do so via slow boat, literally. They're probably not looking to do as much through rail. Again, they're looking at high-speed, low-latency services.

When you look at FedEx and UPS side by side, again, for the 1Q earnings for FedEx, they've got a lot of labor throughput issues right now. That's a function of where they are, we think, in their ground hub automation investment cycle. And also due to some of the peculiarities of their non-union labor force.

So of course, UPS has a higher labor-cost structure with their Teamsters employees. Close to 80% of their workforce is Teamsters. But that also means that their employees have been seeing steady wage increases over the last several years. They are some of the highest comped employees of the parcel network out there. And that's helped the company to attract the labor that it needs to service the demand that we're seeing right now.

- Yeah, it was pretty surprising to see in your report highlighting the fact that UPS almost doubled the margins on small packages, relative to FedEx. They definitely have an edge there. I guess when we think about the pressure now, though, when we're hearing reports of retailers, Walmart, Costco, stepping up to commission their own ships to get stuff over here, I wonder what that does to kind of a UPS, a legacy of provider of logistics here. I mean, is there any implication there on longer-term maybe risks around the thesis?

BRUCE CHAN: Yeah, it's a good question. And it's one that we've been hearing a lot with Amazon, as well, chartering planes, implementing its own long-haul air fleet. We think that this is more of what all of these companies have been doing for a long time now.

Walmart has long in-sourced its own base-load capacity, most particularly with trucking. But they still have upwards of $2 billion in freight spent. So there's a certain amount of base-load capacity that they can haul on their own, it makes sense for them to haul in their own.

But there is a ton of stuff around the fringes, and with other shippers that are certainly much smaller than the likes of Lowe's, Home Depot, Walmart, Target, and Amazon, that need to be moved so. All of these companies can charter ships. They can buy containers. But it's very difficult to operate a network of the size, scope, and scale of FedEx and UPS.

Again, Amazon can buy a few planes here and there, but FedEx and UPS each operate over 400 aircraft apiece. And that's something that is not easily replicable. At least not within the confines of our price-target-time horizon.

AKIKO FUJITA: Bruce, what does the labor picture look like for UPS? I mean, we always hear about ramping up hiring going into the holiday season, but here we are in October talking about a labor shortage. How big of a concern is that in the additional or the increase in wages that are likely to have to come? Does that increase the risk, in terms of cost increases?

BRUCE CHAN: Yeah, absolutely. And we are modeling cost increases. We're budgeting for high single digits, in terms of wages, through the next couple of quarters.

But this is something that UPS has been doing, and FedEx has been doing actually, too, for a long time now. We saw the first big step function in holiday e-commerce rates back in 2013. And since then, they've built very good infrastructure for bringing on these seasonal workers. For UPS, that number is something around 80,000 to 100,000 workers.

And again, we're not saying that there are no labor cost pressures for UPS. We certainly think there are going to be. But I point to two things.

So number one, these are not to the same extent that FedEx is seeing right now, which is labor issues in its fundamental baseload throughput. So they're having to reroute their network. They're having to alter the structure of their network because they can't find the core workers they need. This is not just an issue of higher wages for seasonal workers like we expect for UPS.

And I think the second important point, too, is that we've got a very, very strong yield backdrop. So while we do see these wage pressures, we think that UPS should be able to recapture them through price increases. And you've seen these accessorial fees come through in a big way, just as we discussed with the airlines and with restaurants a few minutes ago.

- Yeah, that's interesting. I mean, all of this this year has been wild to watch. And the upside here, very interesting, 20% upside. We'll see how it plays out.

Bruce Chan, appreciate you coming on here to walk us through the thinking behind it as Stifel Transportation and Logistics Analyst. Thanks again for the time. And the team behind the scenes here raving about some of the points made there.