UPS, FedEx Are Best Barometers of Recovery

BOSTON ( TheStreet) -- Investors searching for signals of the strength of the economic recovery can look to UPS ( UPS) and FedEx ( FDX), which fund managers and analysts say are the best barometers of business activity in the U.S.

As fierce competitors in the shipping business, FedEx and UPS move so much freight that investors are offered a clear view of economic and business activity. With both companies on tap to report financial results for the critical holiday quarter, what they say about business can affect other companies as well.

"Every day, they're moving north of 10% of U.S. gross domestic product combined," says Kevin Sterling, transportation analysts with BB&T Capital. "They're busy, and that's pretty good for the U.S. economy."

Sterling, who has a "buy" rating on both UPS and FedEx, says the shippers may have seen their busiest Christmas on record. But investment manager Dan Genter says investors don't need a quarterly filing to get that information. All they have to do is speak with the local delivery person in the elevator.

"I spoke to our UPS delivery guy the other day and he said they were up 15% year over year," says Genter, CEO and CIO of RNC Genter Capital Management. Genter's firm has $3.6 billion in assets under management and investments in UPS. "They know what's going on. And when UPS and FedEx are picking up, overall business activity is probably picking up even faster because of what is happening off their radar."

UPS and FedEx are up 22% and 16%, respectively, over the past year. And Sterling warns investors that earnings-per-share and revenue data aren't the only figures they should be watching when the shippers report quarterly results.

"When they report Q4, that's in the past. So first and foremost, I'll be looking at the outlook," Sterling says. "The market is a forward-looking mechanism, so that's how investors have to focus. I'll also be looking at key metrics, such as growth in international segments, growth in ground segments, the pricing and margin expansion, as well as any cost headwinds."

Those headwinds are small in number but great in impact. Poor weather conditions across the U.S. have grounded hundreds of flights, which has an effect on shipping. Higher fuel costs likely dented each company's bottom line, as oil rose from below $80 a barrel to above $90 in the fourth quarter. Lastly, the Department of Justice is looking into possible antitrust issues between the two, although Sterling downplays the risk there.

"We'll probably hear about it because it makes for good fodder and good headlines," he says. "But they are both very fierce competitors. They literally hate each other. I can tell you they're not talking to each other. It's like the Hatfields and McCoys."

The DOJ probe comes as both UPS and FedEx have raised prices by 4% to 16% in all shipping segments. So while both stocks have outpaced the broader market's gains over the past year, analysts say investors may still be underestimating the amount of leverage in their models.

"If you get pricing increased, you get that much more leveraged to the bottom line, and you get margin expansion," Sterling says. "That might be the disconnect that people are missing. UPS and FedEx haven't been able to push pricing in the past couple years because of lower volumes. But now they are very, very focused on pricing. That might be where they could surprise."

For that reason, Sterling says he will be paying attention to gross margins. Genter, on the other hand, is looking at the wider view. "The big picture is that the economy is recovering and we have moderate growth," he says. "Businesses are spending and there is more shipping."

On the following pages, TheStreet previews both UPS and FedEx and what investment managers and analysts are looking for in fourth-quarter financial results.

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