FedEx or UPS: A Rivalry Worthy of Your Attention

Jordan is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Bill Ackman can’t stay out of the headlines. This week Reuters reported that the hedge fund manager may be raising a $1 billion fund to invest in FedEx (NYSE: FDX). While we can’t help but get excited about a big investment from a Wall Street titan, a big institutional investor isn't reason to make an investment. 

Let's see what the two delivery giants have to offer investors.

Very different businesses

UPS (NYSE: UPS) and FedEx operate very differently. UPS is primarily a ground shipper that specializes in slower package delivery via its fleet of trucks (and a few hundred airplanes). FedEx specializes in the air, but has a diversified list of businesses that includes a small ground delivery service, freight division, and even a retail business (FedEx Kinkos).

The difference doesn’t just come down to trucks or planes, however. The underlying economics of both firms are very different.

Because UPS relies on trucks to ship its products from place to place, it is much less capital intensive than its peer, FedEx. Focus is what drives UPS’ competitiveness; it is a pure-play on parcel delivery services.

As a result of their fleets and varying business models, the pair generate vastly different returns with their investments. UPS maintains much better asset utilization because it only has one network. Trucks lead its overnight and ground shipping business, whereas FedEx employs two different networks to manage overnight delivery and ground.

In a competitive industry with similar economics, the company that can pump more revenue through the same asset base has better profitability. It should come to no surprise, then, that UPS earns much higher returns on invested capital.

Think about it this way: when a UPS driver covers his area, he delivers several packages. When FedEx covers the same area, it does so with two trucks. UPS has a huge advantage in that it wastes less time, energy, and money to deliver the same number of packages.

Shipping is worth an investment

FedEx and UPS have very wide moats because of the inherent complexity in launching a new delivery service. They are insulated by the “network effect,” which means they have an asset (their delivery service) which becomes more valuable as more customers use it.

The duopoly is the last remainder of the pure parcel service companies after DHL left the market. Fewer participants means better pricing power, better returns on capital, and higher profits for investors. That is, as long as neither aggressively slashes prices to compete – a reality which investors don't anticipate. Rational pricing prevails.

There’s more behind parcel transportation companies than just the moat. Parcel shippers are latching on to explosive growth in online marketplaces.

A value play on e-commerce

Any tangible good sold online is eventually shipped by UPS, FedEx, USPS, or a combination of the three. Thus, UPS and FedEx offer exposure to the fast-growing world of online commerce without the ever-rising multiples in the industry.

Take Amazon (NASDAQ: AMZN), for example. Amazon boasts tremendous top-line growth as a result of its aggressive pricing. Wall Street enables CEO Jeff Bezos with the right to operate a public company with a goal of higher revenue, not profits.

Thus, Amazon shareholders are essentially subsidizing the transportation business. When Amazon drives margins to zero to beat out other retailers and steal share for the Internet, profits flow to UPS and FedEx shareholders, not necessarily Amazon shareholders.

This long-term secular trend toward online commerce is only the beginning. As online retail explodes, so too will unit volumes through UPS and FedEx overnight and ground delivery systems.

That’s what makes FedEx and UPS some of the best plays on Wall Street. Whereas you’ll have to pay for more than a century of Amazon’s current net income to get a slice of the internet retail industry, FedEx and UPS both trade for less than 20 times earnings.

My preference in the space is UPS. While it trades at a premium to FedEx, it earns that premium because it has a focused, more efficient network than its other public rival. Also, it sticks to what it knows, investing only in worldwide shipping, not office supply stores or freight forwarding services.

I like UPS as a long-term play on the Internet, and a play on the most vital business in the world: moving stuff from place to place. This business isn’t going anywhere, and it will only get better with age. That said, shipping companies are a bellwether for the economy. I’ll wait to buy on a dip – investors have plenty of time to wait for a lower valuation. 

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Jordan Wathen has no position in any stocks mentioned. The Motley Fool recommends, FedEx, and United Parcel Service. The Motley Fool owns shares of 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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