2023-11-30 17:00:00 ET
Summary
- UPS lowered guidance and saw a decline in financials, while FedEx fared better and raised their guidance.
- FedEx has shown stronger dividend growth compared to UPS over the past 5 years.
- Both companies have strong balance sheets and are focusing on optimizing growth, but face competition from Amazon.
- UPS made recent acquisitions into healthcare logistics while FDX continues to expand their My FedEx rewards outside of the U.S. into more than 30 additional countries.
- I expect both companies to post better numbers in their upcoming quarters due to the upcoming holiday season.
Introduction
Who here doesn't love a good duopoly battle? Two different companies that essentially do the same thing going toe to toe. I recently wrote an article pitting two other duopolies against each other Home Depot vs Lowe's . Both are high-quality companies that pay dividends, and those who follow my articles know I love high-quality companies that have strong business models, and that also pay growing dividends. Most of us shop at these businesses or use their services, some quite often. I've used both of these companies' services throughout my lifetime, but I've been accustomed to using United Parcel Service, Inc. ( UPS ) more recently as I have one about half a mile away from my house.
FedEx Corporation ( FDX ) is also not far away, about 2 miles. I often try to explain to my friends and sometimes strangers who want to invest that they should start by looking at the things they use every day, especially businesses who pay a dividend like these two. In this article, we'll look at each company's fundamentals and valuations to see which one is the better buy.
Why The Price Disparities?
Both companies have gone in opposite price directions in the last year. FDX is up double-digits while their peer UPS is down double-digits over the same period.
So, why such a disparity in price change for two companies that essentially have the same business? Well, one reason for this is UPS lowered their guidance earlier this year. They also missed revenue during Q3 earnings by $410 million. EPS of $1.57 beat by a penny but financials were down considerably across all segments. The current macro environment is really starting to be felt across the economy. Higher labor costs, tighter consumer spending, etc. are all having a noticeable effect on the sector. Consolidated revenue of $21.1 billion was down 12.8% compared to last year. Operating profit also decreased a whopping 48.7% from last year. EPS also dropped significantly year-over-year by 47.5%. As you can see the disappointment in financials is reflected in the company's price, being down nearly 15% on the year.
UPS also saw lower volumes across all industry sectors as well, with the largest declines in retail and high-tech. The international segment also continues to face headwinds as well, some places more than others. More specifically in Asia and Europe as consumers continue to contend with high inflation and tighter financial conditions. This caused international revenue to drop more than 11% from last year.
The continued headwinds across all segments left management no choice but to lower its full-year guidance. They now expect revenue to be between $91.3 billion to $92.3 billion and operating margins to be between 10.8% to 11.3%. As many may know even high-quality companies sometimes have tough quarters or years and may miss on earnings or revenue. But when management lowers guidance, the price action often falls, at least for a short period. Operating expenses also increased year-over-year as the company executed compensation increases for hourly associates.
Although FedEx experienced a decline in revenue like UPS, the company fared much better, and most importantly, didn't lower their guidance. This is essential because lowering guidance sends a signal to investors and Mr. Market that times are extremely tough, and these times may continue for the foreseeable future. Not just a down quarter. Volumes were also pressured for FDX but they managed to see an increase in some segments, unlike their peer. At FedEx ground revenue and international export packages were up 3% year-over-year. Revenue at FedEx Express and FedEx Freight were down 9% and 16% respectively year-over-year. So while some segments were down, the company did see an increase in some.
Furthermore, FDX delivered $2 billion in cost-saving initiatives and 200 basis points in adjusted margin improvement. This allowed management to increase the lower end of their guidance during Q1 earnings. Based on the solid performance, they now expect adjusted EPS to be in the range of $17.00 to $18.50, raising it by $0.50. So, while UPS was forced to lower their guidance, FDX raised theirs.
Dividend Growth
While I don't knock those who invest in some stocks for short-term profits, I prefer to invest in companies that I view as forever holds. The reason is searching for short-term profits sometimes allows investors to get too emotionally tied to a stock for one reason or another. These can also lead to short-term losses.
I always remember the saying from Warren Buffett: The stock doesn't care. The stock doesn't even know that you own it! By the way rest in peace to Buffett's right-hand man the late great, Charlie Munger. He lived to see 99 years on this earth and I can only hope to live half the time he did.
Both stocks are great for dividend investors also looking for growth. Some may know as I've mentioned in a few of my articles I invest in a mixture of stocks I like to call dividend showers & growers. Having a perfect blend of the two is what I prefer as I plan to supplement my dividends in retirement in the coming years. This year both have increased their dividends, UPS by $0.10 and FDX by $0.11.
Over the past 5 years, which is the minimum amount of data I like to analyze when researching, FDX beats out its peer growing their dividend by 152% compared to 78% for UPS. One way companies continue growing the dividend is by maintaining a safe FCF payout ratio. The earnings payout ratio is important too, but dividends are paid from free cash flow. And the lower the payout ratio, the better chance of the dividend being sustained.
FDX has maintained an FCF payout ratio well below the 60% mark I like to see while UPS' ratio has been elevated recently. But this is expected to decline slightly in the next 12 months. So, as you can see the market is pricing these issues into each company, and that's why FDX has had a green year while UPS has seen a double-digit decline. But with UPS having been around since the early 1900s and maintaining their dividend during the Great Financial Crisis, I expect them to safely navigate these temporary headwinds while maintaining a safe dividend. But if the company's FCF payout ratio continues to remain elevated, there could be a chance of a dividend cut in the foreseeable future.
Balance Sheet Health Check
Both companies are investment-grade rated with UPS having an A-rated balance sheet compared to BBB for FDX. UPS has steadily increased its debt load over the last couple of years while FedEx's debt has slightly decreased over the same period. At quarter end, UPS has roughly $19 billion in debt compared to $20 billion for FDX. Both had ample liquidity of $4.3 billion for UPS and $7.1 billion for FedEx. During earnings, UPS continued its focus on repaying its debt, repaying $1.6 billion and expecting to pay an additional 700 million EUROS in Q4. Although interest rates are and may remain elevated, both company's balance sheets are strong and I don't foresee them having any issues with their debt repayments down the line.
Optimizing Growth
Although both companies experienced revenue declines recently, I expect this to pick up in the next quarter for the upcoming holiday season. Furthermore, UPS announced two acquisitions that will further drive growth for the company in healthcare logistics and end-to-end return solutions. Management plans for the company to become the #1 complex healthcare logistics provider in the world and continue to make moves to get there in the future. Additionally, they expect to win back a majority of its business as it lost 1.2 million shipments during labor negotiations earlier this year.
FedEx recently announced the consolidation of three of their segments into one, Federal Services Corp. The reorganization will reduce & optimize overhead, and streamline their market capabilities, which is expected to improve customer experience. They also expanded the My FedEx rewards program outside of the U.S. to nearly 30 additional countries with nine more European ones expected to launch in 2024. This will likely bring in more customers adding to the company's already strong base. Additionally, FDX expects to retain at least a portion of the shipments that UPS lost during the labor deal.
Valuation
Seeking Alpha Quant system gives both companies a valuation grade of B-. Honestly, I think both trade at decent valuations right now for long-term investors. With UPS having a painful quarter in Q3, investors looking to trade for short-term profits may find them the better buy. Using their price targets, FDX offers more upside. Most Wall Street analysts currently have UPS a hold while others rate it a strong buy. This is the opposite for FDX. Most analysts rate it a strong buy while others rate it a hold. I agree with this as FDX seems to be navigating the macro environment more effectively than their peer currently. Additionally, their financial metrics & balance sheet are slightly stronger with a lower free cash payout ratio and more liquidity available, which is important as interest rates remain elevated.
Risk Factors & Conclusion
One large risk factor both companies face is competition from behemoth Amazon.com, Inc. ( AMZN ). Recently AMZN surpassed both companies to become the biggest delivery service in the U.S. Both companies still remain two of the top 10 shipping services outside the United States but they continue to face headwinds as AMZN continues on its path to growth.
Both companies have faced headwinds because of the current high interest rate environment and I expect this to continue, although subsiding some in the coming months due to the busy holiday season. And are seeking ways to optimize growth and I remain positive they will do well as interest rates begin to decline sometime in the second half of 2024.
In the short term, I think FDX will outperform UPS as reflected in both stocks' share prices. If a recession does come to fruition, this could affect both companies going forward. But with both being investment-grade rated, having strong balance sheets, and being high-quality businesses, I expect them to navigate just fine while facing downward pressures and volatility for the short to medium term.
For further details see:
Duopoly Battle: UPS Vs. FedEx - Which Stock Is The Better Buy Now?