We hosted a conference call, Friday, January 8th with several leading regional parcel companies (OnTrac, Lonestar Overnight, Eastern Connection, Spee-Dee Delivery and U.S. Cargo) to learn more about this small but growing segment of the U.S. small package market.
• Regional parcel carriers are a viable option for parcel shippers; the handful mentioned on the call cover more than 80% of the U.S. population and offer small package services primarily in zones 2-5 (length of haul up to 1,000 miles) with products similar to FedEx and UPS.
• These companies operate in a niche of the parcel market and, in our estimate, still represent on a combined basis ~2% of the overall U.S. market. Their services are useful for many but not all shippers and most often act as a complement to FedEx and UPS rather than a replacement.
• Still, many shippers are unaware these carriers exist and could save money by taking a look at where regional carriers can fit in their supply chain. Regional carrier base rates are most competitive on the next-day products (~40% savings off FedEx/UPS base rates) but still competitive on the ground (~15% savings). Plus, they have fewer surcharges/accessorials, so it is easier to figure out pricing.
• Many ask how they can be cost-competitive with FedEx and UPS with not even close to as much package density, and the answer lies in the simplicity of their networks, direct loading, regional density, and lack of significant infrastructure (no multi-billion dollar hub investments to make).
• Their technology is similar to that of FedEx and UPS, so shippers still have package-level detail, real-time tracking, electronic proof-of-delivery, etc.
• The carriers' market forecast is for slow, steady volume growth, but regional carriers expect a 9%-10% increase in their revenue in 2010 due mainly to rate increases and market share gains.
• Yields are expected to improve mid-single-digits in 2010, assuming improved pricing (DHL's exit is being lapped), stable fuel surcharges and heavier package weights.
• While regional carriers should continue to grow volumes faster than FedEx and UPS, our investment views on FDX and UPS remain unchanged (see page 2 for detail).
Page 2 - Summary thoughts on public parcel giants.
Both FedEx and UPS have recently beaten earnings forecasts mainly due to a combination of aggressive cost cuts and better-than-expected international operations, but is now the time to buy? We remain cautious. While the stocks may rise some in 2010, we do not expect significant outperformance that would cause us to raise our rating on either at this point.
FedEx Corp. (FDX; Hold; $85.50)
• Express margins are the key to overall FedEx EPS growth, in our opinion; that is where the operating leverage is greatest. And International volumes are the main growth area (Asia strong recently). FAA reauthorization bill (House version) contains provision (Oberstar amendment) to reclassify FedEx Express under National Labor Relations Act (vs. current Railway Labor Act status), which would make union organization attempts easier. Even if passed (that language was not in Senate version of the bill), we do not believe FedEx Express would become a Teamster operation but that management focus on blocking unions would detract from overall strategic growth and execution.
• FedEx Ground should continue to take market share from UPS and build density. Main risk to Ground growth is employee/IC lawsuits, but those have been outstanding for some time with no ill effects on business to-date. John Kerry also recently introduced legislation that could toughen independent contractor classification standards, but that is in preliminary stages.
• We do not think Express volumes return as rapidly as some may be pricing in, so we do not expect a return to high single-digit Express margins soon. Company has done a great job cutting costs, but we do not believe there are much more to cut. As Ground service improves (and shippers remain frugal), there should be less of a need for packages to move in the air.
UPS (UPS; Hold; $62.10)
• International Package is the real growth story that can drive earnings, in our opinion; UPS has strong European ground presence (which FedEx does not) and should continue to see international volume growth above domestic volume growth rates via organic growth and acquisitions. Supply Chain Solutions and Freight should also be growth areas but contribute much less to consolidated income.
• Company's largest segment and historical cash cow, UPS Ground, should continue to lose market share to FedEx Ground – the question is at what point does UPS lose enough density to fool around with the annual duopoly price increases? We have not seen a much-talked-about price war yet and do not believe we will at least over the next couple of years.
• UPS is the largest unionized trucking company in the world, and unless FedEx also comes under union attack, we view the company as a very good company with impressive free cash flow but less exciting long-term earnings growth.
In general, we have always favored FDX over UPS with a more entrepreneurial management team, thinner margins (more margin expansion potential), non-union (except for its pilots), and growing into better markets (Ground, International), while losing share in a less attractive market (domestic Express). The exit of DHL almost one year ago helped both, but the benefit was lost in the rounding near-term. With the USPS losing billions and DHL gone, the pricing environment should be very good for both FedEx and UPS for the foreseeable future.
Finally, European and global parcel carrier, TNT, has long-been rumored as an acquisition target for either FedEx or UPS. While we have no knowledge of any M&A negotiations, we think TNT's existing operations (with strong presence in Europe) is more complementary to FedEx's existing service offering but would be wary of purchase price and integration risk were FedEx to buy TNT. With UPS, we see a more difficult integration (overlapping European ground networks) and fewer synergies as reasons we do not believe UPS will buy TNT. Due to the large scale integration expected (and accompanying headaches and costs), we would be inclined to buy the company that does not acquire TNT on the news and sell the company that does, all else equal.
Prices reflect intraday trading 1/13/10.
Page 3 - I, David Ross, certify that the views expressed in this research report accurately reflect my personal views about the subject securities or issuers; and I, David Ross, certify that no part of my compensation was, is, or will be directly or indirectly related to the specific recommendation or views contained in this research report.
“For all relevant disclosures please visit the Research Page at www.stifel.com.”
David G. Ross, CFA can be reached at 443-224-1316 or dross@stifel.com
• Regional parcel carriers are a viable option for parcel shippers; the handful mentioned on the call cover more than 80% of the U.S. population and offer small package services primarily in zones 2-5 (length of haul up to 1,000 miles) with products similar to FedEx and UPS.
• These companies operate in a niche of the parcel market and, in our estimate, still represent on a combined basis ~2% of the overall U.S. market. Their services are useful for many but not all shippers and most often act as a complement to FedEx and UPS rather than a replacement.
• Still, many shippers are unaware these carriers exist and could save money by taking a look at where regional carriers can fit in their supply chain. Regional carrier base rates are most competitive on the next-day products (~40% savings off FedEx/UPS base rates) but still competitive on the ground (~15% savings). Plus, they have fewer surcharges/accessorials, so it is easier to figure out pricing.
• Many ask how they can be cost-competitive with FedEx and UPS with not even close to as much package density, and the answer lies in the simplicity of their networks, direct loading, regional density, and lack of significant infrastructure (no multi-billion dollar hub investments to make).
• Their technology is similar to that of FedEx and UPS, so shippers still have package-level detail, real-time tracking, electronic proof-of-delivery, etc.
• The carriers' market forecast is for slow, steady volume growth, but regional carriers expect a 9%-10% increase in their revenue in 2010 due mainly to rate increases and market share gains.
• Yields are expected to improve mid-single-digits in 2010, assuming improved pricing (DHL's exit is being lapped), stable fuel surcharges and heavier package weights.
• While regional carriers should continue to grow volumes faster than FedEx and UPS, our investment views on FDX and UPS remain unchanged (see page 2 for detail).
Page 2 - Summary thoughts on public parcel giants.
Both FedEx and UPS have recently beaten earnings forecasts mainly due to a combination of aggressive cost cuts and better-than-expected international operations, but is now the time to buy? We remain cautious. While the stocks may rise some in 2010, we do not expect significant outperformance that would cause us to raise our rating on either at this point.
FedEx Corp. (FDX; Hold; $85.50)
• Express margins are the key to overall FedEx EPS growth, in our opinion; that is where the operating leverage is greatest. And International volumes are the main growth area (Asia strong recently). FAA reauthorization bill (House version) contains provision (Oberstar amendment) to reclassify FedEx Express under National Labor Relations Act (vs. current Railway Labor Act status), which would make union organization attempts easier. Even if passed (that language was not in Senate version of the bill), we do not believe FedEx Express would become a Teamster operation but that management focus on blocking unions would detract from overall strategic growth and execution.
• FedEx Ground should continue to take market share from UPS and build density. Main risk to Ground growth is employee/IC lawsuits, but those have been outstanding for some time with no ill effects on business to-date. John Kerry also recently introduced legislation that could toughen independent contractor classification standards, but that is in preliminary stages.
• We do not think Express volumes return as rapidly as some may be pricing in, so we do not expect a return to high single-digit Express margins soon. Company has done a great job cutting costs, but we do not believe there are much more to cut. As Ground service improves (and shippers remain frugal), there should be less of a need for packages to move in the air.
UPS (UPS; Hold; $62.10)
• International Package is the real growth story that can drive earnings, in our opinion; UPS has strong European ground presence (which FedEx does not) and should continue to see international volume growth above domestic volume growth rates via organic growth and acquisitions. Supply Chain Solutions and Freight should also be growth areas but contribute much less to consolidated income.
• Company's largest segment and historical cash cow, UPS Ground, should continue to lose market share to FedEx Ground – the question is at what point does UPS lose enough density to fool around with the annual duopoly price increases? We have not seen a much-talked-about price war yet and do not believe we will at least over the next couple of years.
• UPS is the largest unionized trucking company in the world, and unless FedEx also comes under union attack, we view the company as a very good company with impressive free cash flow but less exciting long-term earnings growth.
In general, we have always favored FDX over UPS with a more entrepreneurial management team, thinner margins (more margin expansion potential), non-union (except for its pilots), and growing into better markets (Ground, International), while losing share in a less attractive market (domestic Express). The exit of DHL almost one year ago helped both, but the benefit was lost in the rounding near-term. With the USPS losing billions and DHL gone, the pricing environment should be very good for both FedEx and UPS for the foreseeable future.
Finally, European and global parcel carrier, TNT, has long-been rumored as an acquisition target for either FedEx or UPS. While we have no knowledge of any M&A negotiations, we think TNT's existing operations (with strong presence in Europe) is more complementary to FedEx's existing service offering but would be wary of purchase price and integration risk were FedEx to buy TNT. With UPS, we see a more difficult integration (overlapping European ground networks) and fewer synergies as reasons we do not believe UPS will buy TNT. Due to the large scale integration expected (and accompanying headaches and costs), we would be inclined to buy the company that does not acquire TNT on the news and sell the company that does, all else equal.
Prices reflect intraday trading 1/13/10.
Page 3 - I, David Ross, certify that the views expressed in this research report accurately reflect my personal views about the subject securities or issuers; and I, David Ross, certify that no part of my compensation was, is, or will be directly or indirectly related to the specific recommendation or views contained in this research report.
“For all relevant disclosures please visit the Research Page at www.stifel.com.”
David G. Ross, CFA can be reached at 443-224-1316 or dross@stifel.com
