Since investors are always going to compare FedEx (FDX 1.20%) with its chief rival UPS (UPS 0.65%), I thought it would be a good idea to weigh the investment cases for their stocks against each other. And doing so leads to some startling conclusions.
UPS and FedEx by the numbers
Given that they having the same transportation end markets and comparable revenues, it's striking that UPS has a valuation that's slightly more than twice that of FedEx. You can see this by looking at the price-to-sales ratio in the chart below.
Data by YCharts
The reason the market has given UPS a valuation so much higher than FedEx's comes down to the fact that UPS is better at generating profits from its revenue. Even more importantly, UPS is much better at generating free cash flow from its earnings.
The chart below shows earnings before interest, taxation, depreciation, and amortization (EBITDA) and free cash flow (FCF) for both companies. (FCF is usually calculated as cash flow from operations minus capital expenditures.)
In sum, UPS converts more of its revenue into EBITDA and then into cash flow from operations. On top of that, its capital expenditures as a share of revenue tend to be lower, helping it generate more FCF. Everything adds up to UPS having better operational numbers than FedEx.
Data by YCharts
This point is highlighted when looking at the fact that, despite having double the market cap and similar revenue, UPS trades at a valuation discount to its rival according to Wall Street analysts' consensus forecasts for FCF. Note that FedEx's fiscal year ends in May, and the full-year figures are adjusted to UPS' fiscal year in the table.
|
Company |
12-Month Trailing Price-to-FCF |
2020 Estimated Price-to-FCF Ratio |
2021 Estimated Price-to-FCF Ratio |
2022 Estimated Price-to-FCF Ratio |
|---|---|---|---|---|
|
FedEx* |
24.3 |
24.7 |
25.3 |
22.5 |
|
UPS |
21 |
25.2 |
21.7 |
19.5 |
Data sources: Company presentations and marketscreener.com. *FedEx figures are adjusted to UPS's fiscal year, which tracks the calendar year; FedEx's fiscal 2020 ended in May.
Two companies, two investment cases
You could make the following cases for each stock based on the data above:
- Buy UPS because it has proven to have better operational metrics such as earnings margin and FCF conversion, and also trades at a discount to FedEx.
- Buy FedEx because it's a similar business to UPS and its management has a long-term opportunity to play catch-up with UPS in terms of operational metrics.
Let's take a closer look at the key issues around each case.
Why both have been under pressure
To understand which stock is better, it's a good idea to look at why earnings margins and FCF generation have been under pressure at both companies in recent years.
Image source: Getty Images.
In a nutshell, surging e-commerce volumes have put pressure on earnings margins. This is partly a consequence of a shift in the mix of what they ship toward lower-margin business-to-consumer (B2C) deliveries. That trend was accelerated in 2020 due to a combination of stay-at-home measures, social-distancing decisions, and a slump in the industrial economy. Nevertheless, the underlying pressures are still there.
Similarly, in order to service all that new e-commerce business, both companies have needed to ramp capital expenditures in order to build out and modernize their networks, which has further pressured their FCF generation.
What management said
That said, the key difference between the two companies right now is that UPS' management appears to be making a more compelling case that it's focused on improving its (already better) operational metrics.
New CEO Carol Tome has wasted no time in making it clear that improving margins and FCF generation are her key goals. For example, Tome told investors to pencil in some $4 billion in capital expenditures for 2021, a large drop from the $5.6 billion in such outlays expected in 2020. On UPS' last earnings call in late October, she promised that in the near future, she would outline her plans to improve margins in 2021.
By contrast, during FedEx's recent earnings call, CFO Mike Lenz told investors that after an $800 million decline in capital spending to $5.1 billion for its fiscal 2021 (which is about half over), the company expects to increase it again in the next fiscal year. "In FY '22, we plan to make additional investments in our FedEx Ground network driven by the surge in e-commerce demand," he said.
Image source: Getty Images.
To be fair, FedEx Ground CEO Henry Maier did say he expected the ground unit's margin to improve "year over year in each of the next two quarters." However, neither he nor Lenz would be induced to forecast what they thought would happen after that.
FedEx or UPS?
While there's no guarantee that Tome will achieve her aims at UPS, she's saying exactly what investors want to hear right now. That's probably enough to give UPS the edge right now, particularly as it's clear that FedEx will be increasing capital spending again in its fiscal 2022. FedEx could play catch-up to UPS in terms of operational metrics, but that's something for the future rather than the here and now.
Throw in the fact that UPS trades at a small discount and has a 2.4% dividend yield compared to FedEx's 1%, and it's clear that UPS is a slightly better buy for 2021.
