Macro Wrap – $FDX vs. $UPS Ratio as a Tell for Beta

by Enis March 21, 2013 7:57 am • Commentary

I promise this will be my last post on FDX.  I’ve dwelled on it from a commentary perspective because it’s instructive of the broader price action, where the markets are rallying without robust earnings data.  I’ve also dwelled on it from a trading perspective because my losing trade is instructive of the importance of choosing the right structure.

We received a good question in our Your Questions Answered section yesterday with regards to the read-through of FDX earnings to UPS.  In short, will FDX weakness affect UPS as well (considering that UPS was only down 1% yesterday)?

FDX is a more leveraged version of UPS.  It has much more operating leverage (7.5% operating margin vs. 2.5% for UPS; 20% gross margin vs. 12% for UPS) – in layman’s terms, a higher sensitivity of earnings to changes in revenues.  In addition, UPS sports a 3% dividend yield compared to 0.5% for FDX.  That increased beta for FDX naturally shows up in the price action.  Here is a 2 year chart of the FDX / UPS ratio:

2 year chart of FDX / UPS ratio, Courtesy of Bloomberg
2 year chart of FDX / UPS ratio, Courtesy of Bloomberg

After hitting a 2 year high early this year (comparable to the July 2011 high), the ratio has dropped sharply in the past month.  While in most parts of the market, owning beta has become the “easy” trade in the past month, it has not worked in the postal transport sector.

Perhaps more notable is the outperformance of health care this year.  It’s the best performing sector in the market this year.  I like the long-term prospects for health care from a valuation and growth perspective.  But the fact that it’s offering the best returns this year with less volatility than traditional beta-driven sectors is surprising.  In the desperate search for yield, health care is one of the few areas where the yield to risk ratio is not dramatically overpriced.  On the other hand, the chase for beta at these levels will likely have a similar result to the FDX/UPS ratio above.