Is UPS Stock A Better Buy Compared To Norfolk Southern?

by Trefis Team
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We think that United Parcel Service (NYSE: UPS) currently is a better pick compared to Norfolk Southern (NYSE: NSC). UPS trades at about 2x trailing Revenues, compared to over 5x for Norfolk Southern. Does this gap in UPS’ valuation make sense? While UPS has benefited from rapid growth in e-commerce, Norfolk Southern has seen increased demand for its Intermodal business. UPS is partly being weighed down by its much lower margins of 6% in 2019 compared to 24% for Norfolk Southern. However, there is more to the comparison. Let’s step back to look at the fuller picture of the relative valuation of the two companies by looking at historical Revenue Growth, Returns (ability to generate profits from growth), and Risk (sustainability of profits). Our dashboard United Parcel Service vs. Norfolk Southern: Is UPS Stock Appropriately Valued Given Its Significantly lower P/S Multiple Compared to NSC? has more details on this. Parts of the analysis are summarized below.

1. Revenue Growth

UPS’ Revenues grew 27% from $58.4 billion in 2015 to $74.1 billion in 2019, aided by e-commerce growth. The growing e-commerce industry has been driving volumes at UPS’s U.S. Domestic Package segment. Many brick-and-mortar retailers have rolled out online shopping portals to cater to the growing online retail shopping customer base and they along with other prominent online retailers, including Amazon, have tied up with logistics companies such as UPS for package deliveries.

On the other hand, Norfolk Southern’s Revenues grew just 7.6%, rising from around $10.5 billion to $11.3 billion over the same period, implying UPS’ revenues have grown at a faster pace over the recent years. For Norfolk Southern, the growth in its Merchandise freight and Intermodal is being partly offset by Coal freight, a trend seen across railroads. With the increased use of cleaner sources of energy such as natural gas, which is also favorably priced, the demand for coal has dropped significantly over the last few years. Consequently, the coal shipments for Norfolk Southern have witnessed a sharp decline.

2. Returns (Profits)

While UPS’ free cash flows as a % of Revenues stood at about 12% in 2019,  increasing from around 11% in 2016, Norfolk Southern’s free cash flows as a % of Revenues stood at about 34%, up from around 31% in 2016. While the Return on Invested Capital metric for both companies has been volatile, UPS’ ROIC was higher compared to Norfolk Southern in 2019, standing at about 30% versus about 12%. Norfolk Southern’s Total Shareholder Returns (TSR) have been higher, driven by a better stock price. Norfolk Southern’s stock price grew 2.8x and its dividend payout ratio declined from 42% to 35% between 2016 and 2019. This compares with stock price growth of 1.8x and dividend payout ratio decreasing from 80% to 75% for UPS over the same period.

3. Risk

UPS’ Debt load is higher at around $26 billion currently, and its Debt to Equity ratio standing at about 25% as of 2019. Norfolk Southern’s debt currently stands at around $13 billion, and its Debt to Equity ratio stood at 23% in 2019 compared to 30% in 2016. Overall, neither company appears to have very meaningful financial risk.

The Net Of It All

Although UPS’ Revenue growth compares favorably with Norfolk Southern, they both are comparable in terms of returns and risk. While Norfolk Southern’s margins are much higher than UPS, we think the difference in P/S multiple of 2x for UPS versus 5x for Norfolk Southern will likely narrow going forward. Both the companies are seeing pickup in demand of late, as the economies open up gradually after the pandemic, and now with a vaccine in the picture, it appears that the worst of the pandemic is behind us. Now UPS’ revenue is expected to grow 16% from $74 billion in 2019 to $86 billion in 2021, while Norfolk Southern’s revenue is expected to decline 6% to $10.7 billion in 2021 compared to $11.3 billion in 2019. With UPS’ revenues expected to grow at a faster pace, the difference in P/S multiple with that of Norfolk Southern is likely to narrow, implying UPS stock could offer better growth in the near term.

What if you’re looking for a more balanced portfolio instead? Here’s a high-quality portfolio to beat the market, with over 100% return since 2016, versus about 55% for the S&P 500. Comprised of companies with strong revenue growth, healthy profits, lots of cash, and low risk, it has outperformed the broader market year after year, consistently.

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