Fedex Corp. vs United Parcel Service, Inc Case Study
2188 WordsAug 3rd, 20109 Pages
I. Executive Summary
In this report we focus on the two main competitors in the package delivery industry: Federal Express Corporation (FedEx) and United Parcel Service of America, Inc.
Studying FedEx, UPS and their competitive relationship in the decade from mid - 80's to mid - 90's gives a good insight for the companies' and industry's future. The two companies have different strategic goals and are operating in the same industry but in different main markets: FedEx is working on "producing outstanding financial returns" and focuses on the overnight air market while UPS is looking for "earning reasonable profit" and its core business is the two-day ground delivery. However, by 1981, the two companies started to have a strong sense…show more content…
In addition to that, FedEx came up with new services such as Saturday deliveries, delivery by 10:30 A.M., customer interfaces (drop boxes, drive through stations and express delivery stores) and same day pickup of order. This is to distinguish its services. More on that, FedEx's philosophy of "People-Service-Profit" was successful in insuring a union free workforce devoted to customer focus. In 1978, deregulation in transportation helped FedEx to acquire larger planes therefore achieve lower cost. Trade deregulation in Asia-Pacific enabled FedEx to expand further. The acquisition of Gelco express, Tiger International, and establishment of Airport Hub in Brussels expanded FedEx internationally. Inflation and rising global competitiveness generated the need for "just-in-time" supply model, which was the advantage supported by FedEx advanced technologies.
Some inhibiting factors were the competition that has heavily evolved as a number of competitors (e.g. Emery, USPS, and UPS) entered the overnight delivery market as well as imitate other FedEx new services. More on that, they were able to acquire similar IT solutions with lower costs and as a result presented these services with cheaper prices. Moreover, in the attempt to expand internationally, some acquisitions were over-priced and revealed insufficient market studying. Europe low demand that resulted in the shutting down of Brussels hub as well as Tiger international operations caused a loss of $1 billion
Both United Parcel Service (NYSE:UPS) and FedEx (NYSE:FDX) have done a solid job of enriching long-term investors over the past 16 years.
|Company||Total Return (2000-2016)||CAGR Total Return|
|United Parcel Service||153.5%||5.6%|
However, as you can see, FedEx has by far been the better choice since that time, courtesy of a faster growth rate. But with the market now trading at all-time highs, and an inevitable correction overdue, the question for dividend growth investors is whether or not UPS and FedEx have what it takes to continue enriching shareholders, growing their dividends, and beating the market going forward.
Let's take a look at why both companies still offer very attractive long-term dividend growth opportunities. More importantly, though, let's find out why at this point in time, UPS is hands down the better company and represents a far better buy for most investors.
UPS: The 800-Pound Gorilla That's Only Getting Bigger
When it comes to international delivery services, UPS bestrides the world as a colossus. Operating in 220 countries and territories around the globe, its 444,000 employees utilize 104,000 vehicles and 543 aircraft to deliver 18.3 million packages per day to over 10 million international customers.
Source: UPS Investor presentation
And while America remains UPS's core market, the company has made great strides in achieving both diversification and growth in the past decade.
In fact, United Parcel Service has proven the far better company at breaking into and expanding its presence around the world, as FedEx has focused more on achieving economies of scale domestically.
And thanks to management's excellent track record of automating its logistical network, an ongoing process that is expected to boost margins and returns on capital in the future (more on this in a moment), as well as consistent share buybacks, 2.4% CAGR reduction over the past five years, UPS expects to be able to achieve impressive earnings growth in the coming years.
FedEx: Smaller Challenger That's Hungry To Unseat The King
Founded in 1973, FedEx founder, Chairman and CEO Fred Smith invented overnight delivery and has turned FedEx into the world's largest express delivery company.
Source: FedEx investor presentation
Over the decades, FedEx has diversified its operations beyond express shipping, and now rivals UPS in the global size of its network, as well as its overall service offerings.
FedEx has historically grown both organically, as well as through numerous bolt-on acquisitions, such as 2015's $1.4 billion purchase of GENCO Distribution Systems, as well as 2016's $4.7 billion buyout of TNT.
This combination has resulted in the smaller FedEx being able to achieve superior growth to UPS, which explains the historically better stock performance.
However as you can see, while FedEx may claim the superior growth mantle, the same can't be said for its profitability.
Profitability: UPS The Clear Winner
|Company||Operating Margin||Net Margin||FCF Margin||Return On Assets||Return On Equity||Return On Invested Capital|
In fairness to FedEx, margins on express shipping are lower than regular ground shipping, which partially explains why UPS has such far superior margins and returns on shareholder capital.
However, another reason is that until recently FedEx was far smaller than UPS, and given the monstrously capital intensive nature of the delivery business, it needed time to achieve sufficient economies of scale.
However, we must also give UPS its due, because management has spent the last decade being very aggressive in automation of its state-of-the-art distribution hubs, as well as maintaining a more modern (and thus more efficient) fleet of aircraft than FedEx.
Source: UPS investor presentation
Those efforts continue today with projects such as ORION, or On-Road Integration & Navigation, which is the company's way of optimizing routes to minimize delivery time, and fuel use. UPS expects ORION alone, once complete, to deliver around $350 million in annual cost savings.
Similarly, the company is investing heavily into automated hubs and distribution facilities and expects that within three years up to 60% of packages will be handled robotically. This could boost efficiency and profits by as much as 25%, which will only further UPS' profitability lead.
Source: FedEx investor presentation
That's not to say FedEx isn't working hard to boost its own margins. As you can see, the company is investing very aggressively into improving its own operations, including newer, more fuel-efficient aircraft, as well as investing $500 million into improving and automating TNT's distribution Hubs. This is part of management's goal of achieving $750 million in annual synergistic cost savings that by itself would nearly double the company's annual free cash flow from 2016 levels.
Balance Sheet: Again UPS Remains Superior
In the past decade, FedEx has funded a lot of its impressive growth with a massive amount of debt. As a long-term dividend investor, I know that an integral part of a secure payout is a strong balance sheet.
|Company||Debt/EBITDA||EBITDA/Interest||Debt/Capital||Current Ratio||S&P Credit Rating|
That is why I like UPS's more conservative use of debt, which creates a lower leverage ratio and results in a much better credit rating that helps to keep its future debt (and capital costs) low. This helps to keep margins strong and the dividend highly secure.
That's not to say that FedEx's debt levels are yet at dangerous levels. After all, its interest coverage ratio remains fantastic, and its debt/capital and current ratios are better than industry average.
Investors just need to be aware that with rates now likely to rise for several years, the days of FedEx being able to fund its aggressive growth plans with ultra cheap debt are likely at an end.
Dividend Profile: FedEx's Superior Growth Prospects Remain Intriguing
|Company||Yield||TTM FCF Payout Ratio||Projected 10 Year Dividend Growth||Projected 10 Year Total Return|
Sources: Gurufocus, Fastgraphs, FactSet Research, Multpl.com, Moneychimp.com
Dividend growth investing is not just about yield, but also about dividend security and long-term growth prospects. After all, studies show that a good long-term rule of thumb for total returns is yield + dividend growth.
From that perspective, while UPS offers the vastly superior yield, FedEx likely is the better dividend growth stock, owing both to its lower FCF payout (which is temporarily elevated) and faster long-term growth trajectory.
Of course, that's only true if FedEx management can execute well on its long-term cost-cutting goals, in order to achieve the kind of EPS and FCF/share growth that will allow it to hopefully grow the dividend at double UPS's rate for many years to come.
Valuation: No Contest, UPS Is The Better Buy Today
|Company||PE||13 Year Median PE||Yield||13 Year Median Yield|
While FedEx's long-term growth prospects are indeed better than those of its rival (at least theoretically), that superior growth is very much priced into the stock. As you can see, while UPS is trading at pretty much its historic PE and yield, from a PE perspective, FedEx looks very much overvalued.
Of course, the true intrinsic value of a stock is based not on the past, but on future earnings discounted to the present. So let's run a discounted cash flow analysis and see what that tells us.
|Company||TTM EPS||10 Year Projected Growth||Fair Value||Growth Baked Into Current Price||Margin Of Safety|
Sources: Morningstar, Fastgraphs, Gurufocus
Just remember that a DCF analysis is far from perfect, as it requires us to extrapolate growth far into the future (in this case 20 years). However, when doing so, we can see that FedEx actually appears to be trading at fair value, while UPS is the one that is a bit richly priced.
Of course, this conclusion is only true if management can hit its long-term guidance because FedEx shares are currently pricing in higher growth than UPS.
By using both the backwards-looking and forward-looking methods, we can conclude that both stocks are either at fair value (given a long enough time horizon) or slightly overpriced, at least historically speaking.
Of course, both are still expected to beat the market in the long term, so opening a position in either is an OK idea, despite neither company appearing cheap.
Just be aware that both stocks are set up for a potentially aggressive pullback, especially given that the stock market is now overdue for a general correction. That means that those looking to add to their positions should probably wait for a 15% to 25% pullback that is likely to occur during the market's next correction.
Risks To Consider
Both UPS and FedEx are deeply exposed to US and global economic growth. In other words, these are not recession-resistant businesses (though the dividend is likely safe during a downturn).
In addition, increasing exposure to foreign shipping means that a strong US dollar, now the strongest in 15 years, could mean additional tailwinds for both companies. This is especially true for FedEx, however, given its smaller size and recent acquisition of TNT, whose successful integration and growth is a key catalyst for the company to expand its sales and margins in the long term.
As long as US economic growth remains superior to that of other major markets such as Britain, the EU, China, and Japan, US interest rates are likely to continue climbing. That would increase demand for the dollar and only make it harder for both companies to achieve their growth objectives.
Additional risks, especially for FedEx, whose employees are mostly contractors, is the risk of unionization, which would raise operating costs and only further harm its already struggling margins.
UPS already has a highly unionized labor force and has managed to capture sufficient operational efficiencies to counter the higher employee compensation costs.
Finally, we can't forget the threat from Amazon (NASDAQ:AMZN), which is aggressively investing in its own delivery systems. While this may not be an existential threat to either company, it is potentially a larger risk to their EPS and FCF growth efforts.
After all, both UPS and FedEx are investing aggressively in ground transport to take advantage of the rise of e-commerce. With Amazon representing 50% of all growth in online deliveries, Jeff Bezos deciding to take delivery in-house, even for just a fraction of the company's delivery needs, could spell big margin trouble for both companies, but especially FedEx, whose much lower margins can't afford to contract as much without threatening the dividend growth thesis.
Bottom Line: Both Great Dividend Growth Stocks, But FedEx Has A Lot To Prove, ESPECIALLY At Today's Valuation
Don't get me wrong, I think that both FedEx and UPS are great long-term dividend growth stocks, which is why I own both in my own diversified income growth portfolio.
That being said, with its superior margins and returns on capital, stronger balance sheet, and higher yield, UPS is clearly the better company at a fundamental level.
And while neither of these delivery giants is cheap right now, UPS's share price, trading at fair value, is far more justifiable than that of its rival.
While I expect FedEx to do great in the future, especially when it comes to boosting operational efficiencies and profitability, at the current valuation, management has a lot to prove. That is why I recommend that investors wanting to own a piece of FedEx wait for a better time before opening a position, much less add to an existing one.
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Disclosure:I am/we are long UPS, FDX.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.