The huge global infrastructures built by UPS (NYSE:UPS) and FedEx (NYSE:FDX) are undoubtedly valuable and expensive to reproduce, but how much are they really worth if the companies cannot drive compelling margins from them? Although UPS has historically enjoyed better margins than FedEx, and the acquisition of TNT should pay dividends in terms of volumes, UPS is struggling to find that sweet spot of volume growth and margin leverage.
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Not Enough Growth for the Multiple
UPS certainly posted growth in the first quarter, but arguably not enough to justify a double-digit enterprise multiple.
Revenue rose 4% as reported, with the company seeing a 4% increase in volume and a nearly 1% improved in yield (that is, pricing). Domestic led the way with 6% growth (4.5% volume, 1.5% price), while international saw 2% growth as volume growth was more limited (2.8%).
Although UPS saw the best volume growth in some time, it didn't translate into significantly better margins leverage. Operating income rose less than 7%, as double-digit growth in the U.S. (up 13%) was offset by a 10% decline in international operating income.
TNT Ought to Help
UPS sealed the deal and announced the acquisition of Dutch logistics and shipping company TNT earlier this year. For close to $7 billion in cash, UPS will vault from the #3 position in most European markets to #1 or #2.
This should help UPS in several ways. For starters, it represents a solid price for a business that is almost exclusively outside the U.S. (where UPS is weaker), and it should produce more volume that can be levered through the system. It also helps UPS insofar as FedEx didn't get it and further their lead on UPS in some markets.
SEE: Analyzing An Acquisition Announcement
Will E-Commerce Deliver the Goods?
UPS has been seeing the expected increase in e-commerce-driven package volumes, but it hasn't really delivered the expected profit leverage. Part of the problem is that these packages are lighter than the traditional business and so the company is losing yield-per-package. Moreover, companies like Amazon (Nasdaq:AMZN) are pushing for better bargains as they realize cheap/free shipping is vital to attracting customers but potentially dangerous to their own margins.
Another LTL Loser
Like FedEx, UPS is not seeing dynamic performance from its LTL trucking business. Like FedEx, this is not really a core operation for UPS and so smaller, more nimble and more focused rivals like Old Dominion (Nasdaq:ODFL) are outperforming.
The Bottom Line
As it stands today, the railroads look like better plays on economic growth. Although UPS does have better margins and returns on capital than FedEx, and has long had better free cash flow production, that doesn't mean that UPS is a bargain on its own. At this point, the Street still seems to be overvaluing the company's market share and asset base relative to its actual ability to generate impressive cash flow.
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At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.