FedEx Keeps Delivering

Whether you believe the economy is rolling toward recovery or just sputtering along, one company long known as a bellwether of business activity, FedEx (FDX ), seems to be moving in the right direction. As the world's largest overnight package-delivery service, FedEx was hit hard last year by the recession and, to a lesser extent, anthrax fears. But the Memphis company's results for the quarter ended Feb. 28 offered ample evidence that business has begun to pick up again.

FedEx reported a net profit of $120 million, or 39 cents per share, up 11% from the 2001 period. Revenues were $5 billion, 4% higher than a year ago. Meanwhile, United Parcel Service (UPS ) reported a 3.3% year-over-year decline in profits, to $563 million, or 50 cents per share, for its first quarter, which ended Mar. 31. Sales were $7.58 billion, up 1.9%.

One reason FedEx has recovered faster than its archrival is that the outfit, long known for its next-day airborne business-package deliveries, has started to encroach on UPS's prime territory: ground shipping by truck to homes and businesses. UPS — described in its latest ad campaign simply as "Brown" for the color of its ubiquitous trucks — has dominated the market for two- to four-day package deliveries for several decades.

"A SWEET NICHE.". The gains on the ground are one reason FedEx has outperformed UPS since the stocks dropped precipitously to 52-week lows in the days following the September 11 terrorist attacks. UPS has bounced back by about 31%, to $60, while FedEx hit a 52-week high of $61 before profit-taking in recent weeks sent it down to $53, still a 62% increase since Sept. 20.

FedEx could continue to outdistance UPS, which is negotiating a major new contract with workers. "In the low $50s, [FedEx] stock gets interesting again," says Lazard Freres & Co. analyst James Winchester. "The FedEx home-delivery product, in particular, is a sweet niche."

Only in the past four years, since FedEx acquired Caliber Systems — UPS's largest competitor in the ground market besides the U.S. Postal Service — has FedEx become serious about offering lower-cost delivery by truck. In 2000, the newly created FedEx Ground unit launched a specialized home-delivery service designed to help catalogers and online retailers more easily ship to consumers' homes.

"EXCEEDING EXPECTATIONS." After pouring more than $800 million into FedEx Ground for new shipping hubs, sorting technology, and package-tracking systems, the investment is paying off. In the most recent quarter, FedEx Ground took in revenues of $668 million, up 26% from last year's $529 million. Operating income was $69 million, a 283% increase. That helped offset a downturn in FedEx's larger overnight-express business, which recorded operating income of $145 million, down 9% from 2001, on flat sales of $3.78 billion.

While the economic downturn continues to hamper bottom-line growth in FedEx's mainstay air-express business, ground shipping is picking up much of the slack. "Ground is exceeding our expectations," says FedEx Senior Vice-President Bill Margaritis. FedEx has sought to distance itself from UPS on the ground, in part by emphasizing services that its rival hasn't offered on a nationwide basis, such as home deliveries on Saturdays and as late as 8 p.m. on weekdays.

UPS hasn't exactly been sweating FedEx's encroachment. FedEx Ground, which delivers an average of 1.7 million packages every day, isn't close to the size or efficiency of UPS, with its more than 13 million daily deliveries. "Clearly, [FedEx] has been pushing lately to try to develop a ground network," says Kurt Kuehn, UPS vice-president for investor relations. "But we feel that we have a broader array of services, and we offer them through one totally integrated system."

UPS'S ASIAN ADVANTAGE. Moreover, UPS is doing its share of encroaching as well. Not only does it offer overnight air delivery that competes with FedEx but it recently opened a major intra-Asia hub in the Philippines, allowing for the acceleration of Asian delivery times. The new hub provides a central sorting point that's within four hours of all major Asian cities. This is important, according to trade and logistics consulting firm MergeGlobal, because the intra-Asia market is expected to grow at an annual rate of 16.8% through 2005.

FedEx has been the dominant player in the B2B express-delivery market in Asia for several years now. But it could be the next great theater of competition between the shipping rivals, analysts believe. "International air express, especially in Asia, is by far the fastest-growing marketplace," says Dan McKinley, analyst for McDonald Investments.

In the short-term, UPS has a dilemma at home that could keep the stock in check. The national UPS labor contract — the largest private, single-employer, collective-bargaining agreement in the U.S., covering more than 210,000 Teamsters — expires on July 31. UPS and the union exchanged contract proposals in January, and negotiations began on Feb. 11. The third round of talks ended on Apr. 19 in Dallas, with no contract signed.

WAITING FOR TECH. While management says a labor agreement is its highest priority and that it remains confident one will be signed before the deadline, the mere mention of a labor dispute makes many investors and shipping customers wary. "There is no way in the world that UPS is prepared to go through a strike again," says analyst Rick Black with Blaylock & Partners. The nationwide strike in 1997, which lasted more than two weeks, caused a severe interruption to daily commerce in the U.S. and cost UPS more than $350 million in profits, he says.

FedEx has no such labor concerns, since, with the exception of its pilots, employees are nonunion or independent contractors. All FedEx investors need to do is wait for the return of tech spending, which would provide a much-needed lift to its overnight-shipping revenues.

While that business hasn't shown signs of a full-on recovery just yet, FedEx' ground-delivery momentum should keep building. The stock may not dazzle, but if the economy continues to pick up strength as expected, it should be a reliable performer in an uncertain market.