FedEx, UPS shares rally as analysts see big holiday season surcharges boosting their bottom lines

Published Thu, Oct 8 20207:00 AM EDT

Jesse Pound @/in/jesse-pound @jesserpound

(This story is for CNBC Pro subscribers only). The looming holiday shopping season could pose a challenge to shipping companies already managing a surge in e-commerce, but that challenge should be a profitable one. As FedEx and UPS have geared up for a busy sprint to the end of the year, including hiring tens of thousands of workers , Wall Street has showered the stocks in a flurry of estimate hikes and upgrades. Those are in part due to the earnings boost expected from surcharges, which can boost bottom lines and direct the largest customers into off-peak shipping times. The use of peak surcharges is not new for the shipping companies, but they could be a bigger factor with e-commerce demand already elevated do the pandemic. "The industry's significant action on surcharges appears to be changing shipper behavior, creating potential for a smoother peak season that allows for more consistent fixed cost absorption," Deutsche Bank said in a note upgrading FedEx to buy from hold. The surcharge strategies for UPS and FedEx are not identical, but they generally apply to the largest customers when they surpass a threshold of packages. UPS, for example, charges an extra 30 cents per package for customers who have surpassed their February average weekly volume by 25,000 packages. Wall Street analysts expect those surcharges to fall to the bottom line and have been hiking their estimates for the current quarter for UPS and FedEx . According to FactSet, Wall Street analysts have raised their estimate for fourth quarter sales by nearly 7% and earnings per share by 12% since the end of July 29 for UPS. For FedEx, whose current quarter ends in November, estimates have gone up by a similar amount for sales and 48% for earnings per share since mid-September. In addition to allowing the parcel carriers to charge more, the surcharges also give leverage to direct large customers on when to ship. On FedEx's earnings call last month, chief marketing and communications officer Brie Carere said the surcharges were part of the strategy to better fit customer demand to the logistics network. "We are rewarding customers that can pull volume forward. We are rewarding customers that can integrate their supply chain, that are open to longer-term contracts," Carere said. By creating that flexibility, the carriers can achieve "good utilization" of the current delivery systems and networks while avoiding angering customers with significant delays, said William Fitzalan Howard, an analyst at Berenberg, helping earnings both in the short and longer terms. "The Christmas of 2013, where both UPS and FedEx really messed this up, was when Amazon first started doing their own logistics after that," Howard said. Both stocks have outperformed the market this year, with FedEx closing at its highest level since January 2018 on Wednesday. Shifting the peak of holiday shopping might make sense for some retailers, as well. A survey from Accenture released in September showed that more than three-quarters of shoppers want their purchases delivered to their doorstep, and the consulting firm urged retailers to find ways to incentivize their customers to shop earlier in the season. Edward Jones consumer analyst Brian Yarbrough said the uncertainty around in-person shopping in late November and December was another reason for retailers to start their holiday seasons earlier. To be sure, the surcharges are not the only thing that has made analysts bullish on the space. One potential near-term catalyst for the stocks is a coronavirus vaccine, which would likely require the national distribution networks UPS and FedEx to reach Americans quickly. Both companies also beat expectations in their most recent earnings reports. The parcel carrier stocks do not have universal approval on Wall Street. FedEx has a buy rating from 71% of analysts and no sell ratings, while UPS has 50% buy ratings and 19% sell ratings. Some firms, like KeyBanc, have an overweight rating on one stock but not the other. "We think that the pie is growing and there's enough share that's good for both of them. Our preference for UPS is that they have more exposure on the U.S domestic product market" while FedEx has more exposure to international air freight, KeyBanc analyst Todd Fowler said.

A United Parcel Service worker delivers packages in New York City.

Stephanie Keith | Getty Images

(This story is for CNBC Pro subscribers only).

The looming holiday shopping season could pose a challenge to shipping companies already managing a surge in e-commerce, but that challenge should be a profitable one.

As FedEx and UPS have geared up for a busy sprint to the end of the year, including hiring tens of thousands of workers, Wall Street has showered the stocks in a flurry of estimate hikes and upgrades. Those are in part due to the earnings boost expected from surcharges, which can boost bottom lines and direct the largest customers into off-peak shipping times.

The use of peak surcharges is not new for the shipping companies, but they could be a bigger factor with e-commerce demand already elevated do the pandemic.

"The industry's significant action on surcharges appears to be changing shipper behavior, creating potential for a smoother peak season that allows for more consistent fixed cost absorption," Deutsche Bank said in a note upgrading FedEx to buy from hold.