Last Mile Home

by Peter Jones, Vice President of Research

Led by a 3.8 percent gain in emerging markets, global equities sustained their upward march. The S&P 500 returned 1.4 percent and closed at yet another all-time high. 10-year U.S. Treasury yields fell seven basis points as soft inflation data weighed on expectations for future interest rate hikes. The Fed continues to grapple with conflicting signals in an attempt to balance the dual mandate of maximizing employment and stabilizing prices. On one hand, tight labor markets argue for sustained interest rate hikes whereas stubbornly low inflation suggests a pause in the tightening of financial conditions. Retail sales disappointed this month while investors welcomed strength in U.S. industrial production. This data supports the notion that economic growth has been buoyed by an acceleration in manufacturing activity.

Shop ‘Till the Mail Drops

It is no secret that shopping preferences have shifted dramatically from traditional brick-and-mortar outlets to online shopping. One of the consequences of this trend is “last mile delivery.” Last mile delivery is the term used to describe package delivery to individual homes. Traditionally, consumer products were delivered in large quantities to a single location such as a mall or department store. On the other hand, last mile delivery often involves one small package per location. From a shipper or parcel company’s perspective, last mile residential delivery is less efficient than traditional business-to-business delivery. As e-commerce continues to increase as a percentage of overall retail sales, more and more package deliveries will fall into this low productivity category. In response to secular changes in shopping behavior, parcel giants UPS & FedEx are investing billions on automated distribution and sorting facilities where they intend for package handling robots and route optimization software to offset the higher costs of last mile delivery.

In an increasingly tight labor market, it is hard to fathom that the supply of courier labor can keep up with the growth of e-commerce unless workers are enticed by significantly higher wages. As the chart below illustrates, this has already begun with courier wages growing more than three times the national rate.

In recent years, e-commerce giant Amazon has conditioned shoppers to expect minimal shipping costs. To protect their profits, e-tailers demand low shipping prices from delivery companies. The combination of inefficient last mile delivery and price sensitive customers would appear to spell trouble for parcel companies and this bearish backdrop is reflected in price-to-earnings multiples for both FedEx and UPS.

On the contrary, senior management at FedEx argues that rapid e-commerce growth, a shortage of labor and underinvestment in additional capacity from the United States Postal Service will ultimately lead to robust pricing power for package delivery services. Economic theory contends that it is unrealistic to expect the cost of labor to increase at the same time the price of delivery decreases. As such, the pessimistic scenario reflected in the current market values of parcel companies underestimates future price increases as the balance of power shifts from e-tailers and consumers, to delivery service companies.

Takeaways from the Week:

  • Emerging markets continue to lead global equities
  • Conflicting economic signals weigh on the Fed as it considers additional rate hikes
  • As labor markets continue to tighten, shipping costs may be subject to price increases