United Parcel Service Delivers the Goods

While United Parcel Service (UPS) and FedEx (FDX) both have attractive characteristics that should translate into above-average gains for shareholders, we think UPS has more to offer at this point. Not only is "brown" bigger, but in many cases it is also simply better.

UPS is far more profitable, and its margins have consistently remained well above those at FedEx. In fact, the firm's margins and free cash flow generation are both at the top of the entire industry. That free cash flow has enabled UPS to maintain a rock-solid balance sheet, which has garnered a coveted AAA rating from leading credit agencies. Furthermore, UPS is simply more efficient, boasting much higher returns on equity [ROE], as well as solid returns on invested capital [ROIC] approaching 20%.

In late January, the company announced solid year-end figures, with fiscal 2006 producing record highs in revenues, operating income and earnings per share. While some analysts quibbled over the firm's softer near-term domestic outlook, we like where UPS is headed on the international side. Over the past year, average domestic daily package volume has ticked up +4.4% to hit 13.8 million. However, international package volume has climbed a robust +17.3%.

Combined, the company shipped 15.6 million packages per day -- about 560,000 more per day than in 2005. Meanwhile, revenues per piece have been marching higher well -- up +2% last year to $9.70. As a result, revenues for the year climbed +12% to $47 billion.

More importantly, the company was able to squeeze $5.7 billion in operating cash flows from those sales, enough to repurchase 32 million shares, pay $1.7 billion in dividends, and still plow $3.1 billion back into the business. And with $2 billion in cash on the books, ramped-up share repurchases and/or another dividend hike could be on the horizon.

Looking ahead, we think UPS will continue to capitalize on the booming Chinese economy, where the firm controls a staggering 85% of the nation's exports. At the same time, UPS has expanded its service to many of the world's top 30 markets, and going forward will have delivery options to regions covering 80% of the world's GDP.

Yet, for all the advantages at UPS, the shares are still attractive, trading at a hefty 18% discount to fair value -- more than double the 8% at FedEx.

All things considered, either of the stocks could deliver for shareholders in the years ahead, but UPS has a better shot at arriving at that destination first.

Comments

[CATHY GORDON]

Nathan Slaughter

What impact do you feel the 3 lawsuits from UPS Franchisee of TUPSS and Mail Boxes Etc and the appeal on certification for class of Converted TUPSS will have on the UPS stock?

Cathy G

[Jim Beranger]

I don't see how a suit against an aggregate unit of UPS can have any noticable impact on its stock price. The fundamentals are very strong, even with MBE/TUPSS taken out of the picture.

[Aaron Brask]

I like both of these companies as well. I agree that UPS' numbers are slightly better (ROIC etc), I compute different figures (still good for both). But I disagree that bigger = better. FDX is growing quicker, perhaps as a result of stealing mkt share, and this is likely attributable to its smaller size. Moreover, you can't ignore the the higher potential for a bid from someone else (eg, priv equity or UPS!? Doubt the latter in reality). Lastly, I think FDX has a slightly higher % revenue from outside the US which I think is better. On balance, FDX wins me over.