“A penny saved is a penny earned,” Benjamin Franklin, the nation’s first postmaster. once said — and in the wake of the U.S. Postal Services $5.5 billion pension payment default last week, his 237-year-old agency will have to save a lot pennies fast. FedEx’s (NYSE:FDX) nearly $1.5 billion annual postal services contract, which expires next September, is a great place to start.
Package delivery rival United Parcel Service (NYSE:UPS), which did about $100 million in business with the Post Office in 2011, already has thrown its hat into the ring for a shot at the lucrative air transport contract that FDX has held since 2001.
Although the USPS is technically a competitor with UPS and FDX, that relationship is also cooperative. With their expansive aircraft fleets and robust logistics networks, the package companies can transport domestic mail by air more efficiently. Since mail shipments typically fly during the day, the carriers can maximize the utilization of planes that otherwise would sit idly. As a result, both carriers benefit from handling domestic mail.
For the past 12 years, FDX has benefited more because it holds USPS’s single largest air transport contract, which accounted for about 3% of FedEx sales in the past fiscal year. Under its terms, the carrier provides domestic air transport for the Post Office’s First Class, Priority Mail and Express services.
But the Postal Service has lost some $6.6 billion in its past two fiscal quarters alone. Congress’ 2006 requirement that the service prefund retirees’ health benefits by $5.5 billion a year further strains the beleaguered entity. By opening up the bidding for its mega-contract to other carriers — most notably UPS — the Postal Service stands a good chance of reducing its costs considerably.
UPS and FDX are both suffering from slumping international earnings and margins. With pressure from Europe and Asia likely to continue through the rest of the year, an extra billion dollars could come in handy for UPS. Conversely, FedEx can ill-afford to lose the bulk of the Postal Service’s mail volume.
So, would the potential loss of the Post Office contract deal a crushing blow to FDX? And would a big contract win give UPS a competitive edge too great to overcome? In my view, the answer to both questions is a resounding “No.”
1. FedEx can still raise prices. Despite stagnating global economic growth and higher expenses, time is on FedEx’s side. And by time, I mean customers’ constant need to get parcels to their destinations quickly. Although cost-conscious shippers are shipping fewer express packages these days, FedEx’s most recent earnings still grew by 14%, and it still has a lot of pricing power.
2. UPS faces macroeconomic challenges, too. Brown may be a lot bigger than UPS, but its size hardly grants it immunity from the global slowdown. Although UPS has done a good job of coping with global headwinds so far, pressure on its growth will become a major problem if the global economy continues to weaken, as InvestorPlace’s Tom Taulli points out in this Pros and Cons.
3. FDX has very attractive fundamentals. UPS has the size advantage, and it generates a lot of cash, but don’t count out FedEx. With a market cap of nearly $73 billion, UPS has $6 billion in cash, but also debt of $12 billion. The $28.7 billion market cap FDX has $2.8 billion in cash and debt of less than $1.7 billion. UPS has a price-to-earnings growth (PEG) ratio of 1.5, indicating that the stock is overvalued. It also has a forward multiple of over 14. With a PEG ratio of only 0.8 and a forward P/E of less than 11, FedEx looks undervalued. UPS does shine on the dividend front, however, with a current yield of 3%, compared to FDX’s scant 0.6%.
4. USPS will probably split the contract anyway. Unless a dark horse like Air Transport Services Group’s (NASDAQ:ATSG) ABX Air or privately held Atlas Air emerges (or UPS seriously low-balls its bid to gain the business), I’d expect a split contract between the two heavyweights. The ABX and Atlas fleets are too small to vie for the lion’s share of the mail transport volume, and FDX’s past performance is strong enough to ensure it isn’t locked out of the new contract entirely. Even if UPS wins a large chunk of the contract, it will incur up-front expenses as it prepares to support the new business.
Bottom Line: The tough global economy will take a toll on UPS and FDX earnings this year, making the new Post Office contract a bigger deal for the companies than it otherwise might have been. Although FedEx could lose a piece of this contract to UPS, its strong fundamentals and pricing power still make it a good choice for investors’ portfolios now.
Of course, it’s always prudent to remember another piece of sage advice from Ben Franklin: “Applause waits on success.”
As of this writing, Susan J. Aluise did not hold a position in any of the stocks named here.