Summary
- Despite their dominant position, neither FedEx nor UPS have a recent compelling record of creating shareholder value.
- Dividends are safe and there is minimal business risk with either company. But there is little beyond dividend safety that they can offer.
- Even with their stocks meaningfully below their respective 52-week highs, it is probably best to look elsewhere for value.
Introduction
UPS ( UPS ) and FedEx ( FDX ) dominate the small package delivery services in the US. UPS gets 76.45% of its revenue from the US, while FedEx derives 69.45% of its revenue from US. Both companies offer competing services and both companies are pro-cyclical. Both businesses are built on the transport of goods. If there are less goods produced or purchased, their business suffers.
Source: 10-K for fiscal year 2021 for UPS and 10-K for fiscal year 2022 for FedEx.
There are notable differences between the companies. For one, FedEx is structured as a holding company which provides strategic direction to operating companies. For example, pick-up and delivery drivers operate as independent contractors. They pay for their own expenses and have some control over hours worked. They are compensated based on the number of packages delivered. With FedEx, ground packages are routed differently than express packages. By contrast, more than 70% of the 444,000 UPS US based employees are represented by unions. UPS operates an integrated network with a single pickup and delivery network for the different package services (air, ground, domestic, international, commercial, residential).
They also have different areas within the market that they focus on. For UPS, ground delivery is their largest segment. UPS operates a ground fleet of 121,000 vehicles and an air fleet of 288 aircraft. FedEx’s main segment is express. FedEx’s 696 aircraft is 2.4x more than UPS’s air fleet and their 86,000 vehicles is 71% of UPS’s ground fleet.
Notwithstanding their differences, there are important similarities. Both companies are impacted by the cost of fuel in a similar fashion. Both companies employ similar tactics by passing on “fuel surcharges” to their customers. They also seem to increase their prices at about the same time each year and at about the same general rate.
In this article, we assume an investor is indifferent to the idiosyncratic risks associated with each company. We explore which of the two stocks (if any) should be considered for a value-oriented portfolio. Our criteria for evaluating the respective securities is to examine their recent operating track record with emphasis to how much shareholder value was created. We use Buffett’s maxim that “for every dollar retained by the corporation, at least one dollar of market value will be created for the owners” as our yardstick.
Earnings Yield
Please take a look at Table 1 in which we look at the inverse of the P/E ratio for UPS and FedEx. The earnings yield has the benefit of quantifying what return at the current price can the investor expect. The earnings yield is how much we are willing to pay for a share of the profits. From Table 1, it appears that investors are willing to give up 130 basis points for a share of UPS’s profits relative to FedEx. At least from an earnings yield perspective, FedEx is giving us 17.15% more yield per dollar invested.
Table 1: Earnings Yield. | ||
UPS | FDX | |
Price | $ 170.40 | $ 162.34 |
Forward earnings estimate | $ 12.91 | $ 14.42 |
Earnings yield | 7.58% | 8.88% |
Source: Price is quoted from CNBC.com and is an intraday price for 11/8/22. Forward earning estimate is from Seeking Alpha. Earning estimates are for fiscal year ending 12/31/22 for UPS and 5/31/23 for FedEx.
Capital Asset Pricing Model
In Table 2, we infer the intrinsic value of the two firms using the cost of equity. We come up with the cost of equity using the Capital Asset Pricing Model. Using the same rate for the 10-year Treasury and the same equity risk premium the determinant for the cost of equity will be the company’s beta statistic. FedEx has a higher beta which translates to a higher cost of equity. Despite the higher cost of equity, FedEx is trading at a lower premium to implied value.
Table 2: Value Relative to Capital Asset Pricing Model. | ||
UPS | FDX | |
Beta | 1.09 | 1.31 |
10-year Treasury | 4.14% | 4.14% |
Equity Risk Premium | 5.50% | 5.50% |
CAPM Cost of Equity | 10.14% | 11.35% |
Implied Value | $ 127.36 | $ 127.08 |
Current Price to Implied Value | 33.80% | 27.74% |
Source: Beta statistic and the 10-year Treasury are from CNBC. Equity risk premium is an estimate.
Credit Rating
Please take a look at Table 3 in which we look at the credit rating of UPS and FedEx. UPS has a one notch better credit rating than FedEx. FedEx is rated one notch above speculative grade.
Table 3: Issuer Credit Rating. | ||
UPS | FDX | |
S&P | ||
Rating | A | BBB |
Outlook | Stable | Stable |
Moody's | ||
Rating | A2 | Baa2 |
Outlook | Stable | Stable |
Source: www.spglobal.com, www.moodys.com.
Earnings Growth
Please take a look at Table 4 in which we look at the earnings growth record of the two companies. The two companies have different fiscal years. For FedEx, their fiscal year ended May 31, 2022. For UPS, their fiscal year ended December 31, 2021. I have used the most recent annual data for each.
Table 4: Earnings per Share ((EPS)) and Growth Rate. | ||||
Year | UPS EPS | Year | FDX EPS | |
2015 | $ 5.34 | 2016 | $ 6.51 | |
2016 | $ 3.86 | 2017 | $ 11.07 | |
2017 | $ 5.61 | 2018 | $ 16.79 | |
2018 | $ 5.51 | 2019 | $ 2.03 | |
2019 | $ 5.11 | 2020 | $ 4.90 | |
2020 | $ 1.54 | 2021 | $ 19.45 | |
2021 | $ 14.68 | 2022 | $ 14.33 | |
2015-2021 CAGR | 18.36% | 2016-2022 CAGR | 14.05% | |
2015-2019 CAGR | -1.09% | 2016-2020 CAGR | -6.86% | |
2019-2021 CAGR | 69.49% | 2020-2022 CAGR | 71.01% |
Source: 10-K for UPS for the years 2015 to 2021 and 10-K for FedEx for the years 2016 to 2022 . CAGR stands for Compounded Annual Growth Rate.
Earnings for UPS seem somewhat flat from 2015 to 2019. There was a big drop in 2020 followed by an almost threefold increase in earnings in 2021 from 2019.
For FedEx, the earnings appear inconsistent. For the fiscal year 2021 and 2022, earnings were a multiple of the previous two years.
Let us consider the dividend growth record to complement the earnings growth picture.
Dividend Growth
Please take a look at Table 5.
Table 5: Dividend per Share ((DPS)) and Growth Rate. | ||||
Year | UPS DPS | FDX DPS | ||
2015 | $ 2.92 | 2016 | $ 1.00 | |
2016 | $ 3.12 | 2017 | $ 1.60 | |
2017 | $ 3.32 | 2018 | $ 2.00 | |
2018 | $ 3.64 | 2019 | $ 2.60 | |
2019 | $ 3.84 | 2020 | $ 2.60 | |
2020 | $ 4.04 | 2021 | $ 2.60 | |
2021 | $ 4.08 | 2022 | $ 3.00 | |
2015-2021 CAGR | 5.73% | 2016-2022 CAGR | 20.09% | |
2015-2019 CAGR | 7.09% | 2016-2020 CAGR | 26.98% | |
2019-2021 CAGR | 3.08% | 2020-2022 CAGR | 7.42% |
For UPS, the dividend growth record for 2019 to 2021 is lower than the dividend growth record for the entire period presented, despite the earnings growth rate for 2019 to 2021 period being significantly higher than the entire period presented. This may be the management telegraphing that they don’t see the earning growth rate for the 2019 to 2021 period as being representative of what investors can expect. For 2015 to 2019 time period, which we will consider the “normalized” time period the dividend growth rate is a respectable 7.09%. However, the corresponding earnings growth rate from the previous table is negative 1.09% which doesn’t inspire confidence in terms of dividend coverage.
For FedEx, you also have a dividend growth rate for the 2020 to 2022 time period that is lower than the entire period presented despite the earnings growth for the particular period exceeding the earnings growth for the entire period presented. If we consider the 2016-2020 time period as the “normal” time period, FedEx boasts a dividend growth record of 26.98% which is very good. Unfortunately, earnings growth for the period was a negative 6.86% which doesn’t make this an obvious and compelling story.
Perhaps we can get some reassurance by looking at cash flows.
Cash Flow from Operations
Please take a look at Table 6 and 7 in which we look at cash from operations, capital expenditures and dividends. The right most column is arrived after subtracting capital expenditures and dividends from cash flow from operations.
Table 6: UPS Selected Cash Flow Metrics. Per Share Data. | ||||
Year | Cash from operations | Capital Expenditures | Dividends | Total |
2015 | $ 8.20 | $ 2.63 | $ 2.92 | $ 2.66 |
2016 | $ 7.30 | $ 3.34 | $ 3.12 | $ 0.83 |
2017 | $ 1.69 | $ 5.97 | $ 3.32 | $ (7.60) |
2018 | $ 14.61 | $ 7.22 | $ 3.64 | $ 3.75 |
2019 | $ 10.06 | $ 7.43 | $ 3.84 | $ (1.21) |
2020 | $ 12.13 | $ 6.28 | $ 4.04 | $ 1.81 |
2021 | $ 17.27 | $ 4.83 | $ 4.08 | $ 8.36 |
Table 7: FedEx Selected Cash Flow Metrics. Per Share Data. | ||||
Year | Cash from operations | Capital Expenditures | Dividends | Total |
2016 | $ 20.46 | $ 17.27 | $ 1.00 | $ 2.19 |
2017 | $ 18.26 | $ 18.95 | $ 1.60 | $ (2.29) |
2018 | $ 17.18 | $ 20.82 | $ 2.00 | $ (5.64) |
2019 | $ 21.18 | $ 20.72 | $ 2.60 | $ (2.14) |
2020 | $ 19.45 | $ 22.40 | $ 2.60 | $ (5.54) |
2021 | $ 37.82 | $ 21.96 | $ 2.60 | $ 13.26 |
2022 | $ 36.96 | $ 25.42 | $ 3.00 | $ 8.54 |
As the reader will note, neither company covers their capital expenditures and dividends from cash from operations in every year presented. This does not lend clarity to forming a reasonable growth and coverage estimate for either company.
Retained Earnings
Please take a look at Table 8 which exhibits earnings and dividends paid for UPS from 2015 to 2019, our “normal” time period. In business theory, earnings in a particular year can be attributed to all the capital invested in the business up until just before the particular year. So, in theory, earnings in 2019 for a business can be attributed to all the invested capital in the business from inception up until the end of 2018. In 2019, the capital was put to use and delivered earnings for the owners of the business. We are going to narrow the scope and look at retained earnings from 2015 to 2018 for UPS and attribute earnings in 2019 to retained earnings from 2015 to 2018.
Table 8: UPS Retained Earnings. | |||||
2015 | 2016 | 2017 | 2018 | 2019 | |
UPS EPS | $ 5.34 | $ 3.86 | $ 5.61 | $ 5.51 | $ 5.11 |
UPS dividends per share | $ 2.92 | $ 3.12 | $ 3.32 | $ 3.64 | $ 3.84 |
Dividend payout ratio | 54.68% | 80.83% | 59.18% | 66.06% | 75.15% |
Retained per share | $ 2.42 | $ 0.74 | $ 2.29 | $ 1.87 | $ 1.27 |
Cumulative retained earnings 2015-2018 | $ 7.32 | ||||
Growth in earnings, 2019 minus 2015 | $ (0.23) |
In Table 8, we can see that from 2015 to 2018, UPS’s management kept a cumulative of $7.32 of investor money. This figure is the sum of the retained per share for 2015, 2016, 2017 and 2018. In 2019, UPS delivered $5.11 in earnings per share. So, UPS’s management kept $7.23 of investor money and delivered negative 23 cents per share in incremental earnings for the period. Earnings in 2019 was 23 cents less than it was in 2015. At least for the time period presented, UPS did not deliver incremental returns on the retained earnings.
We do the same analysis for FedEx in Table 9 adjusting for the differing fiscal period. From 2016 to 2020, FedEx retained $29.20 in investor money and delivered a negative incremental return of $1.61 for 2020 as compared to 2016. For the time period presented, FedEx doesn’t appear to put retained earnings to good use.
Table 9: FDX Retained Earnings. | |||||
2016 | 2017 | 2018 | 2019 | 2020 | |
FDX EPS | $ 6.51 | $ 11.07 | $ 16.79 | $ 2.03 | $ 4.90 |
FDX dividends per share | $ 1.00 | $ 1.60 | $ 2.00 | $ 2.60 | $ 2.60 |
Dividend payout ratio | 15.36% | 14.45% | 11.91% | 128.08% | 53.06% |
Retained per share | $ 5.51 | $ 9.47 | $ 14.79 | $ (0.57) | $ 2.30 |
Cumulative retained earnings 2015-2018 | $ 29.20 | ||||
Growth in earnings, 2019 minus 2015 | $ (1.61) |
We shall examine the use of retained earnings further, but at this stage, it is difficult to support a buy thesis for either company when there is a question on management’s ability to deploy retained earnings.
Market Value Added
Please look at Table 10 which highlights the earnings of UPS and the average share price for the particular year. Using a similar logic as we have employed, we can say that from 2015 to 2018, UPS retained $7.32 per share of investor money and created $5.84 in value. We get $5.84 from the average share price in 2019 minus the average share price in 2015. Thus, for every dollar retained, UPS created 80 cents in value. This fails Buffett’s test that for every dollar retained, at least a dollar in value should be created.
Table 10: UPS Retained Earnings and Share Price. | |||||
2015 | 2016 | 2017 | 2018 | 2019 | |
UPS EPS | $ 5.34 | $ 3.86 | $ 5.61 | $ 5.51 | $ 5.11 |
UPS dividends per share | $ 2.92 | $ 3.12 | $ 3.32 | $ 3.64 | $ 3.84 |
Retained per share | $ 2.42 | $ 0.74 | $ 2.29 | $ 1.87 | $ 1.27 |
Average share price | $ 103.05 | $ 103.66 | $ 114.64 | $ 114.16 | $ 108.89 |
P/E ratio | 19.30 | 26.85 | 20.43 | 20.72 | 21.31 |
Cumulative retained 2015-2018 | $ 7.32 | ||||
Value added per share | $ 5.84 | ||||
Value added per $1 | $ 0.80 |
Source: For average share prices for Table 10 & 11, I used weekly closing prices from Yahoo! Finance and computed the average for each period.
In Table 11, we look at FedEx’s record of value creation. From 2016 to 2020, FedEx retained $29.20 per share and created negative $14.49 in value. -$14.49 is computed as the average price in 2020 minus the average price in 2016. So, for every dollar retained, FedEx "destroyed" 50 cents in value for the time period presented.
Table 11: FDX Retained Earnings and Share Price. | |||||
2016 | 2017 | 2018 | 2019 | 2020 | |
FDX EPS | $ 6.51 | $ 11.07 | $ 16.79 | $ 2.03 | $ 4.90 |
FDX dividends per share | $ 1.00 | $ 1.60 | $ 2.00 | $ 2.60 | $ 2.60 |
Retained per share | $ 5.51 | $ 9.47 | $ 14.79 | $ (0.57) | $ 2.30 |
Average share price | $ 155.28 | $ 176.84 | $ 239.60 | $ 209.42 | $ 140.78 |
P/E ratio | 23.85 | 15.97 | 14.27 | 103.16 | 28.73 |
Cumulative retained 2015-2018 | $ 29.20 | ||||
Value added per share | $ (14.49) | ||||
Value added per $1 | $ (0.50) |
Conclusion
The FedEx and UPS duopoly dominate the market for small-package delivery in the US. Duopolies may be questionable from an economic good or free market perspective but they are usually very good for the owners of the companies. This doesn’t appear to be the case with either FedEx or UPS. Neither company has created meaningful value for their shareholders in the recent past. These two companies are financially solid and are integrated in the fabric of the economy and there is minimal business risk with an investment position in these companies. However, for investors looking for more than safe dividends, there is no obvious path to wealth compounding here. For value, look elsewhere.
For further details see:
FedEx And UPS: For Value, Look Elsewhere