Trucking Over The Competition
Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Since I've been following stocks for almost 20 years, my family knows that I'm always curious about companies they notice doing well. This prompted a recent question by my mom who asked, “is FedEx (NYSE: FDX) a public company? I just know I see those trucks all over the road.” I've looked at FedEx before in comparison to their primary competition United Parcel Service (NYSE: UPS). In that prior post, I concluded that UPS seems to offer a better value. While FedEx had a rough quarter in the last three months, patient investors should be rewarded.
The third and fourth quarter of the calendar year should be busier for both FedEx and UPS due to the upcoming holiday shopping season. With this in mind, it makes sense to re-examine these companies to see which might offer a better opportunity for investors. Unless you live under a rock, most people know that the U.S. Postal Service has been struggling mightily. I've even read articles suggesting that one of the major shipping companies should take over the post office to try and right the ship. While I don't personally believe this will happen, the struggles of the post office end up generating additional demand that both FedEx and UPS can capitalize on. In addition, the ongoing strength of online retailers such as Amazon.com and eBay should continue to drive shipping volumes. If the economy continues to improve, both companies should benefit from the additional shipping needs of both businesses and individuals. One big difference between FedEx and UPS is the fact that FedEx operates a division called FedEx Office that is complementary to their delivery service.
In my own area, FedEx Office only has a few very small competitors that are mostly privately owned. On a larger scale, a company like Pitney Bowes (NYSE: PBI) is one of this division's primary competitors. Pitney Bowes has been helping individuals and businesses with their shipping needs for over 100 years. The big difference between this company and FedEx is, the fact that Pitney Bowes is attempting to diversify away from their traditional mailing and shipping business, whereas FedEx is using this division as a complementary offering to their traditional shipping services. Additionally, while Pitney Bowes is expected to see somewhat anemic earnings growth, analysts expect FedEx to grow earnings by more than 13% in the next few years. In addition, these two companies are on the complete opposite end of the yield spectrum. While FedEx has a history of raising its dividend, the company's current yield stands at less than 0.75%, whereas Pitney Bowes has a yield north of 10%. I've written in the past, that I believe Pitney Bowes dividend is going to be around for a while. There is a very different dynamic at FedEx that makes this company attractive as well, but investors need to be patient.
Admittedly the company's most recent quarter wasn't that impressive. FedEx reported revenue of just 3%, and EPS down 0.68%. The company specifically blamed, "week global economic conditions" for these lower results. However, when you really dig into the earnings report, the main problem is the company's FedEx Express unit. This is both good and bad news for investors. FedEx Express is just one division, but represents the largest share of revenue. This unit showed revenue up just 1%, which was primarily due to a -4% foreign currency exchange impact. While revenue per package did increase 2%, package volumes overall were down 5%. With small single-digit declines in revenue and package volumes, clearly the company needed to adjust its expense structure as operating income dropped 28%. With such a significant drop in operating income, I have to wonder if FedEx was being somewhat unrealistic about the growth they previously expected from this unit. If that is the case, the company needs to trim the fat, get realistic about growth for this division, and operating income should stabilize. When you look at the company's two other divisions results were relatively good.
FedEx Ground showed revenue up 8%, and operating income increased 9%. Though this division represents less than half the revenue of FedEx Express, it contributed more than double the operating income. This unit saw package volume up 5%, but what was most interesting was the company's Smartpost solution saw volume jump 18%. Smartpost could be best compared to standard first class mail. The delivery time is between two and seven days, and the maximum weight is 70 pounds. In fact, you could make the argument if the U.S. Post Office continues to struggle, this particular offering could become more and more attractive as a solution. The company's FedEx Freight division also did well, increasing revenue by 5%, and operating income jumped 114%. As you can see, between FedEx Ground and FedEx Freight the company is doing well. If they can get operating costs for FedEx Express under control, the overall result would be much better earnings. When it comes to the company's financial statements, there were a few things I noticed that could be improved, and one big longer-term concern.
The first issue I noticed is, the company's purchased transportation costs increased 11% from $1.52 billion to $1.68 billion. This is a significant expense and indicates that the company did not have enough productive assets to handle deliveries on their own. Depreciation also increased 13%, but this is less of an issue as this is a non-cash expense. With both of these expenses increasing at a much faster rate than revenue, it's not hard to understand why FedEx ran into a challenge growing earnings. A larger issue that I noticed is, the company is carrying $5.5 billion in pension, post retirement, and benefits costs on the liability side of the balance sheet. While this isn't a concern at the moment, the company will eventually need to set aside funds to cover these expenses. When it comes to their main competition, the real question for investors is, will FedEx return to their winning ways, or would investors be better off with UPS?
Analyst generally expect FedEx to outgrow UPS over the next several years. Both companies have a history of increasing their dividend, but UPS offers a far more attractive yield at over 3%. However, for patient investors, I believe that FedEx can be at least as good of a play as UPS if not better. Though the company has a lower gross margin than UPS, this is a positive if the company is able to cut expenses to improve their margins. With UPS sporting a gross margin above 75%, and FedEx at less than 64%, you can see there's room for improvement. FedEx also has a history of beating earnings estimates. If analyst are correct, the company will not only outgrow UPS, but the outperformance should be more significant than the current numbers reflect. While the company's guidance was lower-than-expected, the economy seems to be on better footing than last year. If the holiday shopping season is stronger than last year, this company should keep on trucking.
MHenage has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend FedEx and United Parcel Service. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.