This Stock Is Likely To Outperform United Parcel Service

by Trefis Team
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We think that FedEx stock (NYSE: FDX) currently is a better pick compared to United Parcel Service stock (NYSE: UPS), given its lower valuation, better revenue growth, and profitability. FedEx trades at about 0.7x trailing revenues, compared to 1.9x for UPS. Although both the companies saw a rise in revenue during the pandemic, as more people ordered goods online, FedEx stock has been weighed down after it reported Q1 fiscal 2022 results, which were below the street estimates, owing to increased labor costs. 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 as well as operating margin growth. Our dashboard UPS vs FedExSector Peers; Which Stock Is A Better Bet? has more details on this. Parts of the analysis are summarized below.

1. FedEx’s Revenue Growth Has Been Stronger

Now, although UPS’ revenue grew at a CAGR of 9% during the last three year period, in-line with the 9% CAGR for FedEx, the latter has performed better over the last twelve month period, with FedEx’s revenue rising 21% vs. 14% for UPS. FedEx’s revenue rose 21% in fiscal 2021, and, looking forward, it is expected to rise 8% in fiscal 2022 to $91 billion, while UPS’ revenue is expected to rise 12% in 2021 and 3% in 2022 to $95 billion and $98 billion, respectively.

For both the companies, revenue growth over the last year or so was triggered by shelter-in-place restrictions, resulting in more online orders. However, looking forward, with the rise in vaccination rate, the residential volume of ground deliveries is likely to see a slowdown, as people start to venture out of their homes. The international deliveries business has seen strong growth over the recent quarters, a trend expected to continue in the near term, with passenger travel still well below the 2019 levels. Our UPS Revenues and FedEx Revenues dashboards provides more insight on the companies’ revenues.

2. FedEx Has Seen Better Margin Growth

Similar to the pattern seen in revenue growth, FedEx’s operating margin of 8% over the last twelve month period is much better than just  3% for UPS. Even if we were to look at last three fiscal year change in operating margin, FedEx’s 7% figure is way better than UPS’ -1% change. FedEx’s operating margin of 8% over the last twelve month period compares with 2% in 2019, before the pandemic. The current operating margin of 3% for UPS is lower compared to FedEx, and it compares with the 10% figure in 2019. We expect margins for both companies to face some headwinds in the near term, given the inflationary pressure and limited labor availability resulting in higher wages, as stated by FedEx’s management in the recent earnings call conference. While fuel prices have also increased nearly 2x over the last year or so, this cost is partly offset by fuel surcharges levied to the customers. A few years back FedEx margins were adversely impacted due to high integration costs for the TNT acquisition, but most of those costs are now behind the company and FedEx is likely to see margin expansion in the long run.

The Net of It All

Now that over half of the U.S. population is fully vaccinated against Covid-19, with overall economic activity picking up, the demand for ground deliveries is likely to slow going forward (compared to the surge seen over the last year or so), impacting the revenue growth for both the companies. That said, as the Covid-19 crisis winds down, the demand for express shipping and freight business is likely to rise. Covid-19 is proving more difficult to contain than initially thought, due to the spread of more contagious virus variants and infections in the U.S. are higher than what they were a few months back. This has weighed on FedEx’s margins in the last quarter, and it is likely to have an impact on UPS as well, when it reports its Q3 results later this month.

FedEx’s current valuation is surely more attractive than that of UPS, with FDX stock trading at about 0.7x trailing revenues, versus 1.9x for UPS, and FedEx has demonstrated better revenue growth and margin expansion in the recent past. However, if we were to look at financial risk, FedEx’s 35% debt as a percentage of its equity is much higher than 16% for UPS, and FedEx’s 9% cash as percentage of assets is also slightly below the 10% figure for UPS, implying that UPS has better debt as well as cash position. The financial risk to some extent also explains the difference in valuation of both the companies. That said, given the lower valuation, better revenue and margin growth for FedEx, we think this gap in valuation between UPS and FedEx will likely narrow going forward in favor of the less expensive stock – FDX. In fact, going by our FedEx Valuation of $326 per share, there is an upside potential of over 45% from the current levels of around $224.

While FDX stock may see higher levels, 2020 has created many pricing discontinuities which can offer attractive trading opportunities. For example, you’ll be surprised how counter-intuitive the stock valuation is for 3M vs. FedEx.

 

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