The internet has materially changed the way customers shop. It increased both the number of packages that are delivered directly to a person's home and the range of companies that can sell directly to customers. On the surface, that should be a net win for shippers of all kinds, but it's not that simple. That is why it's so interesting to compare XPO Logistics (NYSE:XPO) and United Parcel Service (NYSE:UPS). Is either better positioned for the future today?
What they do
UPS is probably the simpler of the two to understand. Although it has expanded into various aspects of the shipping business, its core is to quickly deliver individual packages. To do this, it has built up a massive global organization that is incredibly efficient at collecting and delivering boxes. It also provides less than truckload services and logistics, but combined these are only about 16% of the company's revenues.
As it is currently structured, XPO Logistics is focused on supply chain management, logistics, and less than truckload services (more on this below). So while it doesn't deliver packages exactly like UPS, the two do end up competing with each other. XPO's core customer is, basically, a company. UPS's customer is a bit harder to define, spanning both the corporate and individual space, being that the end recipient is often an individual consumer.
The internet and competition
The growth of internet shopping and global commerce have been hugely beneficial to XPO and UPS. Revenues at both have trended generally higher at each company over the past decade, for example. Competition, meanwhile, has been intense, since each faces multiple peers, but a rising tide has lifted boats throughout the shipping space. Notably, XPO has historically focused on acquisition-led growth while UPS has largely grown via internal investment.
That said, a key customer has become a key competitor for both UPS and XPO. Amazon (NASDAQ:AMZN) has increasingly expanded its reach into shipping, reportedly killing its relationship with XPO in 2019 as it brought some of its logistics efforts in-house. But Amazon's ambitions are far larger, as it is also building out the ability to deliver packages to individuals, as well, reaching into UPS's space. This isn't a small issue, since Amazon is a massive force in e-commerce and has a long history of being an industry disruptor.
UPS, meanwhile, has a history of not being able to execute particularly well during peak delivery season (basically, the end of year holidays). To fix this, it has been spending heavily to upgrade its network. In 2020 it will put roughly $6.5 billion toward this effort. Amazon is a key customer and one that UPS hopes to continue working with, so this spending is important. But Amazon's efforts to deliver its own packages makes the outlook for their partnership a little uncertain. It is entirely possible that Amazon will end its relationship with UPS just like it was rumored to have done with XPO. UPS has other relationships, for sure, but losing Amazon would be a big blow, as some estimate it accounts for around 10% of UPS's revenues.
This is where things get a little confusing. UPS is sticking to its knitting and doubling down to upgrade its operations for the future. The problem here is that Amazon is increasingly focused on shipping, with a recent Morgan Stanley report suggesting that Amazon isn't just looking to deliver its own wares to customers, but may consider expanding to provide delivery services for others, as well. UPS could be doubling down only to see 10% of its business go away and, importantly, the entrance of a well-financed competitor in Amazon.
Complicating this is that UPS has a debt-to-equity ratio of 6.6 times, which is much higher than direct competitor FedEx, which has a debt-to-equity ratio of roughly one time. (FedEx, by the way, made the decision to stop working with Amazon in favor of working more closely with Amazon's competitors.) Spending heavily while dealing with an already heavily leveraged balance sheet isn't exactly a great combination. The future for UPS is kind of up in the air right now and investors are well aware of it, with its shares still 23% below their early 2018 highs.
XPO, meanwhile, has decided that it no longer wants to grow via acquisition. Instead it intends to shrink by selling off big parts of its operation. The remaining XPO will be focused on the domestic less than truckload operation, its biggest segment. It made a point of highlighting that this division saw a 150 basis point improvement in its adjusted operating ratio in the fourth quarter, continuing a trend of relatively strong performance. That said, the biggest benefit from asset sales is likely to be financial flexibility, as the company's liquidity should increase as the cash from these sales rolls in. That could allow XPO to invest in its business or even jump back into the acquisition game.
The problem here is that there's still a lot of work to do before XPO has slimmed down to just the less than truckload business. In fact, it hasn't sold anything just yet. So XPO's future looks interesting, but is far from certain right now.
Long-term investors need to tread with caution and don't have to, as investing legend Warren Buffett likes to say, swing at every pitch. Between UPS and XPO, it looks like XPO's breakup plans could be the more interesting approach, since the company will be raising cash as it refocuses on its best division. UPS's plans for heavy capital spending in the face of a leveraged balance sheet and increasing competition from a key customer just doesn't feel like quite as strong a path. That said, neither XPO nor UPS seem like particularly great options for most investors today, which is doubly true for those with a conservative bent. It would probably be better to keep both of these names on your watch list for now until there is a little more progress along their very different paths.