The perennial question facing investors in the package delivery industry: Should you chooseFedEx Corporation (NYSE: FDX) or United Parcel Service (NYSE: UPS) stock? Or even buy both -- or avoid both? Let's take a look at the relative merits of each company and speculate on which stock is the better buy.
Continue Reading Below
Comparing UPS and FedEx
It's easy to fall into the trap of thinking that FedEx is just an equivalent version of UPS but with a smaller market cap. However, the businesses have a number of key differences that investors should consider. Moreover, some of these differences have led FedEx to outperform UPS in recent years.
- FedEx has separate air and ground networks, whereas UPS has an integrated network.
- Across a raft of operational metrics, UPS is the more productive company.
- UPS has had a harder time adjusting to surging e-commerce growth, and consequently has had to ramp up capital expenditures in response.
Helping UPS outperform FedEx in 2017? Image source: United Parcel Service, Inc.
Putting these points together, FedEx's less profitable and productive network has proven better at handling e-commerce growth than UPS' integrated network has done in recent years. For evidence of how much more productive UPS is compared to FedEx, see the metrics below. Whether it's operating margin, return on invested capital (ROIC) or generating free cash flow (FCF) from assets, UPS is better.
Continue Reading Below
FedEx is dealing with e-commerce growth better
Both companies have faced margin pressure from e-commerce growth, but UPS has been more negatively affected. UPS' performance metrics have suffered more from the difficulties inherent in servicing e-commerce growth, and particularly during peak season. One example is the increased capital expenditure plans of UPS compared to FedEx. As you can see below, UPS' capex to revenue has crept up in the last year or so.
Indeed, UPS CFO Richard Peretz now expects capital expenditures to be 6%-7% of revenue in 2018-2019 compared to a 2014 estimate for 4.5%-5% in 2015-2019.
Moreover, the difficulties in dealing with peak e-commerce demand during the holiday season have meant that UPS' sequential growth in profitability has decreased from the third quarter to the fourth quarter (which contains the holiday period).
Data source: United Parcel Service, Inc presentations. Chart by author.
As you can see below, FedEx's stock price performance has trumped that of UPS in the last five years.
Why UPS can outperform
With all that said, I believe that UPS stock could outperform FedEx's. There are four main reasons:
- The updated guidance at the UPS investor conference -- operating profit growth is seen as growing at 5%-9% in 2018-2019 from previous guidance for 8%-11% in 2015-2019 -- has now reset investor expectations.
- While FedEx's integration of TNT Express contains upside potential, it also contains risk.
- The pressures on ground margin from e-commerce growth are being dealt with in similar fashion by both companies through a variety of pricing measures -- this should help UPS in particular, as it's been more negatively affected.
- As you can see below, despite increased capex requirements, UPS remains the cheaper stock on a price-to-free cash flow basis.
A line in the sand
By putting these points together, we can see that the case for UPS outperforming FedEx is based on the idea that UPS has now readjusted investor expectations, and investors should not be facing up to any disappointments with regard to having to materially ramp capital expenditures in the future.
In other words, the negative news flow from UPS will hopefully abate and the market will favor the stock with a better history of cash flow generation and a lower valuation.
10 stocks we like better than United Parcel Service
When investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*
David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now and United Parcel Service wasn't one of them! That's right -- they think these 10 stocks are even better buys.
Click here to learn about these picks!
*Stock Advisor returns as of April 3, 2017