Over the last three years, United Parcel Service (UPS 2.42%) has produced a higher total return than the S&P 500 and the industrial sector. And even after its 4.5% decline on Friday in response to a bleak outlook from FedEx (FDX 0.59%), UPS stock is barely underperforming the market this year.
The issue is that UPS last reported earnings in late July. And if the industry is as bad as FedEx is making it out to be, then there's a risk that UPS will cut its full-year guidance and report worse-than-expected results when it announces earnings in late October.
Here's why UPS remains a buy despite FedEx's warnings, and why investors would do well not to assume that UPS will cut its guidance to the same degree as FedEx did.
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The better bellwether
Despite not even cracking the top 100 S&P 500 stocks by market cap, many investors still turn to FedEx for a reading on the broader economy. On Sept. 16, financial headlines focused on FedEx's pre-announcement, and many fear that FedEx's guidance for lower package delivery volumes signals weaker consumer demand.
While FedEx accounts for a large share of U.S. package delivery volume, it provides more of a premium service than the U.S. Postal Service, Amazon, or even UPS. Its main premium service is expedited shipping through FedEx Express.
In fiscal 2022, FedEx Ground only accounted for 36% of revenue and 42% of total operating income, while FedEx Express made up nearly half of revenue and 47% of operating income. FedEx Express continues to be the company's differentiating factor.
The drawback of FedEx Express is that its performance can be relatively volatile, benefiting when customer demand is good and the economy is growing and slipping when the company's customers are facing compressed margins and begin cutting back on expedited shipping.
Meanwhile, UPS should be viewed as more of a bulk shipping service. In 2021, its U.S. domestic package revenue accounted for 64% of total revenue, while U.S. domestic package delivery made up 55% of total adjusted operating profit.
UPS and FedEx operate sizable, high-margin international and freight segments. But the main difference between the two is that FedEx focuses on speed and convenience while UPS leans into affordable solutions that cater to a mix of residential customers, big companies, and small and medium-size businesses. In sum, UPS is a better bellwether as a package delivery company than FedEx is.
The better business
Although UPS could cut its guidance when it reports earnings in October, the differences between FedEx and UPS mean that the two companies are not an apples-to-apples comparison. The nature of FedEx Express might lead you to believe that FedEx tends to sport higher margins than UPS. But the opposite is true.
UPS operating margin (TTM). Data by YCharts.
Beginning about eight years ago, UPS began to separate itself from FedEx, consistently posting much higher operating margins. UPS' success with small and medium-size businesses, the healthcare industry, automotive, and its "better, not bigger" framework have led to improved routes and efficient operations, and UPS now is much more profitable than FedEx. One of the best ways to understand the differences between UPS and FedEx is by looking at the 10-year changes in capital expenditures (capex), revenue, and operating income.
UPS capital expenditures (TTM). Data by YCharts.
You'll notice that FedEx routinely spends more on capex than UPS. In fact, its trailing-12-month (TTM) capex is at a 10-year high, while UPS' TTM capex is at a five-year low. Although UPS makes slightly more revenue than FedEx, its TTM operating income is more than double that of FedEx, proving the company is much better at converting similar sales into higher profits.
UPS is an excellent long-term buy
UPS has a market cap of around $154 billion, compared to FedEx's $42 billion market cap after Friday's sell-off. Although FedEx looks cheaper, UPS remains a better buy.
The company has done a superior job managing expectations and exceeding goals ahead of schedule. The profitability of its business, not to mention its ability to register a higher operating margin while deploying less capex, is a testament to why it is a better company to invest in than FedEx.
If FedEx turns itself around, it could very well outperform UPS, given the depressed levels in its stock price. But with UPS' 3.3% dividend yield, a reasonable valuation, and an impeccable management team, investors would do well to take advantage of the dip in UPS stock.
