The perennial question facing investors in the package delivery industry: Should you choose FedEx 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.

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.
A UPS employee standing in front of a delivery truck.

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.

UPS Return on Invested Capital (TTM) Chart

UPS Return on Invested Capital (TTM) data by YCharts.

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.

UPS CAPEX to Revenue Chart

UPS CAPEX to Revenue data by YCharts.

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). 

Q3 to Q4 profit growth has slowed dramatically in recent years

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.

UPS Chart

UPS data by YCharts.

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.

UPS Price to Free Cash Flow (Annual) Chart

UPS Price to Free Cash Flow (Annual) data by YCharts.

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. 

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.