The big delivery giants UPS (NYSE: UPS) and FedEx (NYSE: FDX) have long been viewed as growth stocks with some of the attributes of value investments. Yet this may not be the case because both parcel and letter carriers have reported dramatically slowing revenue growth.
The value case for FedEx and UPS is easy to make because both companies have some traditional value attributes. The companies are simple they offer a basic and easy to understand service that is not sexy but vital to the success of our modern economy. Both companies also pass Warren Buffett’s idiot test that is their service is so simple an idiot could run it.
The growth case is also easy to make as ecommerce grows and grows and demand for delivery increases. The numbers certainly support this argument: Ycharts reported that Amazon.com’s (NASDAQ: AMZN) revenue was growing at a rate of 15.08% on March 31, 2015. On February 25, 2015, Market Pulse reported that Target’s online sales grew by 36% in the fourth quarter of 2014, while Walmart’s grew by 18%.
Increased Online Retail Does Not Translate into Delivery Revenue Growth
More importantly, these companies do seem to have a moat around them. When you order something online in the United States these days, you have three basic choices unless you live in Brooklyn or San Francisco. You can use FedEx, UPS or the United States Postal Service (USPS).
Yet something very interesting happened recently; Ycharts.com reported that revenue growth for both UPS and FedEx had slowed dramatically. On May 31, 2015, FedEx reported a year to year revenue growth rate of 2.32% down from 3.53% in May 2014. On March 31, 2014, UPS reported a rate of 1.44%, down from 5.63% as recently as June 2014.
What Is the Cause of Delivery Services’ Revenue Decline?
The wide moat and fast growth in online retail are not translating into large-scale revenue growth at the major delivery services. Instead, they seem to have reached some sort of limit to their growth, but what is that limit?
It is not fuel prices; on June 29, 2015, the United States Energy Information Administration (EIA) reported that the average price of a gallon of gasoline in the USA was 90¢ lower than on the same date in 2014. Diesel fuel was even cheaper; the cost of a gallon of diesel was $1.08 less than in 2014.
Perhaps it is other factors, such as labor costs. FedEx and UPS both have fairly high labor costs even though they use different labor solutions. FedEx drivers are contract employees, while UPS drivers are employees and Teamsters’ Union members.
Competition is not to blame because outside the big cities of San Francisco and New York, alternatives to FedEx and UPS in the delivery business are fairly limited. Services like UberRUSH, Postmates, Kroger’s Home Shop, Walmart to Go, Google Express and Amazon’s Prime Now and On My Way are little more than experiments confined to a few regions. It must also be pointed out that these services concentrate on segments of delivery that FedEx and UPS have historically ignored, such as retail click n’ pull and grocery delivery.
There are, of course, a wide variety of operating costs in delivery, including insurance, vehicle maintenance, new vehicle purchase, and warehouse space to name a few. An increase in any of these could quickly cut into revenue.
UPS and FedEx Are Still Very Good Investments
The revenue decline aside, data from Ycharts indicates that UPS and FedEx are still very good investments. On March 31, 2015, UPS reported the following appetizing numbers that should make a value investor’s mouth water:
- A dividend yield of 2.89%
- A diluted EPS of 3.425
- A profit margin of 7.35%
- A return on equity of 73.49%
- A free cash flow of $2.386 billion
- A net income of $3.147 billion
- A market capitalization of $87.45 billion
- An enterprise value of $94.07 billion
- A TTM revenue of $58.43 billion
The numbers Ycharts provided show that Mr. Market’s favorite, FedEx, was not doing nearly as well. On May 31, 2015, FedEx actually delivered some disappointing numbers, including:
- A dividend yield of .5%
- A diluted EPS of 3.09
- A profit margin of -7.39%
- A return on equity of 5.89%
- A free cash flow of $515 million
- A net income of $907 million
- A market capitalization of $48.48 billion
- An enterprise value of $51.69 billion
- A TTM revenue of $47.45 billion
My take on it is that UPS is still a really good company in a great position, while FedEx is weak. It also appears that delivery growth is weak or has hit some sort of plateau.
An Uncertain Future
One problem facing both FedEx and UPS is that future growth in online retail is going to come in areas outside their normal business.
For example, much of the new ecommerce business will come from discounters that will use the cheapest shipping method possible, which is almost always the post office. Free shipping options like Walmart’s offer of free shipping for purchases over $50 and Target’s free shipping offer for purchases over $25 are designed to encourage customers to choose the cheapest option.
Another potentially big area of growth for e-tailers will be groceries and same day delivery. Almost all such deliveries are done in-house through the company’s own drivers or through courier services. One problem here is that many of the orders now delivered by UPS or FedEx will be handled through these solutions in the future.
For example, a Walmart order usually shipped via FedEx from a fulfillment center might be shipped directly to a customer’s house from the local store in areas with Walmart to Go. In a few years, an electric razor ordered from Walmart.com could be pulled off the shelves at the local store and handed to an UberRUSH driver or bicycle courier for delivery to the customer.
Compounding these threats is the declining use of paper documents; for example, the replacement of paper checks by electronic payments and the decimation of paper books by solutions like Kindle.
FedEx and UPS are good companies, but they seem to have reached the limits of their growth. My prediction is that both companies will remain profitable, but they will struggle to maintain growth for the next decade or so. UPS in particular is still a value investment because of its strength in delivery. FedEx could be more vulnerable because it has fewer resources.