Can FedEx Deliver More Than UPS?


By Amy Tsao The U.S. economy is on the mend, and nowhere is the buzz of increasing business activity louder than at package-delivery giants FedEx (FDX) and United Parcel Service (UPS). In their recent updates, the two indicated that the recovery would be a boon to their bottom lines. "I expect both companies to do very well," says Standard & Poor's equity analyst Jim Corridore. "Investors can profit in either of these stocks." He rates both stocks 5 STARS, or buy, S&P's highest rating.

That rating isn't the only thing they have in common. Memphis-based FedEx, traditionally seen as the choice for overnight air deliveries over long distances, is making inroads into Atlanta-based UPS's core business of ground-based deliveries.

"ROOM TO EXPAND." Meanwhile, UPS has been spending heavily to further develop its air business. And each has expanded its retail presence: UPS bought Mailboxes Etc. in March, 2001, and FedEx acquired Kinko's in January. Each also is well positioned to dominate package delivery in emerging markets like China.

For all their similarities -- including the likely bump from a buoyant economy -- many analysts say FedEx will have stronger stock performance over the next year. As of the closing bell on Sept. 9, more-profitable UPS was trading at $73.40, or 22 times expected earnings per share (EPS) of $3.35 for the fiscal year ending in December, 2005.

FedEx closed at $84.58, or 18 times expected EPS of $4.60 for the fiscal year that ends in May, 2005. That price-earnings difference should narrow if operating margins at FedEx come closer to those at UPS, analysts say. "UPS has excellent return metrics on any measure, but FedEx could have more room to expand as a stock," says Corridore.

GAINING GROUND. For one, FedEx' ongoing expansion into ground deliveries is still in its early stages. That business generally has higher margins and is growing at a faster clip than overnight services. "FedEx is picking the low-hanging fruit," says Pete Maher, analyst at Bryn Mawr Trust Wealth Management. (Maher doesn't own the stock, but his firm does.)

Since 2000, when ground delivery became a high priority for FedEx, the business has grown considerably. In the fiscal year ended in May, it brought in about 16% of total revenues of $24.7 billion. FedEx has seen profits per package improve as its share of the ground-delivery market has grown -- at the expense of UPS and the U.S. Postal Service. (For more on FedEx, see BW, 9/20/04, "Frederick W. Smith: No Overnight Success".)

UPS, on the other hand, is looking to reinforce its air operations. Brown is expected take delivery of 12 new aircraft in 2004, has committed to buying 63 planes through 2009, and has an option on 60 more. Its fleet now consists of 600 aircraft. Analysts say the heavy investment in air operations could put UPS's margins -- which have long been significantly wider than those of FedEx -- under pressure. In their respective most-recent quarters, UPS's operating margin was 14.47% vs. 9.73% at FedEx.

JUMBO ADVANTAGE. "It's not that margins at UPS aren't great. The question is where will they be?" says Don Broughton, an analyst at A.G. Edwards. "At some point in the next five years, it's possible we'll see both companies producing similar operating margins." UPS's per-package profitability has declined some, thanks in large part to wage increases for its mostly unionized staff. Raises will add some $700 million in costs annually over the next four years, Broughton figures. (Broughton does not own either stock, and his firm has no banking relationship with the companies.) He rates FedEx buy and UPS neutral.

S&P's Corridore points out that FedEx is better positioned in China, a key growth market. FedEx has twice as many airport landing spots as UPS. Broughton says FedEx' advantage will increase in 2008, when it acquires larger-capacity planes that can "be used in the big, long-haul routes," such as those to the Middle Kingdom.

UPS is unruffled by comparisons with FedEx, pointing out that with $33.5 billion in sales last year, it's still the overall leader in package delivery. "We have better asset utilization and higher service levels with a single network that delivers multiple products and services," says Teresa Finley, vice-president for investor relations. UPS aims to report 15% operating margin by 2007 across all of its businesses. It says a new and more efficient sorting and transporting "package flow" technology will result in $600 million in savings by 2007. FedEx declined to comment for this article.

BROWN'S GOLD. Certainly, some analysts are skeptical that FedEx will have an easy time catching UPS on the ground. With its better profit margins and stronger balance sheet, "UPS has more control of its destiny," says analyst Nicholas Owens of Morningstar, an independent stock-research provider. He says by 2014, even if their businesses are virtually identical, UPS will still have "better margins and return on capital."

Few doubt that the economic rebound will lift both FedEx and UPS. But analysts think FedEx, even with its higher-priced stock, has more room to travel. Whether its profits can soar to surpass industry leader UPS's is another question. Tsao covers the markets for BusinessWeek Online and writes for the Street Wise column


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