KULLIYYAH OF ECONOMICS AND MANAGEMENT SCIENCES

CORPORATE FINANCE

(FIN 4040)

CASE ANALYSIS:

“THE BATTLE FOR VALUE, 2004: FEDEX CORP. VS. UNITED

PARCEL SERVICE, INC.”

PREPARED BY:

1328350 ANIS SYAZIANIE BINTI CHE MOHD ZAIMI

1323568 SHARINA AZLEEN BINTI ERMAN EFENDI

1321976 AFIFAH NABILAH BINTI MOHD SAFEI

1329010 MUNIRAH BINTI RAMLI

1322836 RUZANA BINTI SUHAIMI

SECTION: 4

SESSION:

SEMESTER 1, 2016/2017

LECTURER:

DR. ROSLILY BINTI RAMLEE

SUBMISSION DATE:

19TH DECEMBER 2016

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CONTENTS

1.0 INTRODUCTION ...................................................................................................................... 3

2.0 QUESTIONS .............................................................................................................................. 4

2.1 QUESTION 1 .......................................................................................................................... 4

2.2 QUESTION 2 .......................................................................................................................... 5

2.3 QUESTION 3 .......................................................................................................................... 5

2.4 QUESTION 4 ........................................................................................................................ 15

2.5 QUESTION 5 ........................................................................................................................ 17

3.0 CONCLUSION ............................................................................................................................. 18

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1.0 INTRODUCTION

In June 18, 2004, United States and China signed a landmark air-transportation

agreement that will increase by five times the number of the commercial cargo flights

between the two countries. This agreement also allows for the establishment of air-cargo hubs

in China and landing rights for commercial airlines at any available airport. This gives

opportunity to FedEx Corporation (FedEx) and United Parcel Service Inc. (UPS), the only

US all-cargo carriers to be permitted to serve the vast Chinese market. Thus, the stock price

for both companies rises steadily since the talks began with FedEx outperformed UPS by

almost five times faster.

FedEx Corporation was founded in 1971 and suffered severe losses in 1973. By 1976,

FedEx finally got their profit of $3.6 million on an average daily volume of 19,000 packages.

However, in 1981, even though FedEx generated more revenue than any other US air-

delivery company, the competition in the industry had started to rise. During 1990s, FedEx

proved itself as an operational leader and has received the prestigious Malcolm Baldrige

National Quality Award from the President of the United States. The success was credited to

the deregulation and operational strategy as well as FedEx’s philosophy of ‘People-Service-

Profit’. By the end of 2003, FedEx had nearly $15.4 billion in assets and net income of $830

million on revenues of about $22.5 billion. The company had about 50, 000 ground vehicles,

625 aircraft, 216,500 full-and part-time employees, and shipped more than 5.4 million

packages daily.

United Parcel Service (UPS) was founded in 1907 and was the largest package-

delivery company in the world. Known in the industry as Big Brown, UPS was an industry’s

low cost provider, had been investing heavily in information technology, aircraft, and

facilities to support service innovations, maintain quality and reduces cost. By 2003, UPS

offered package-delivery services throughout USA, and moved more than 13 million

packages and documents through network every day. At the year-end 2003, UPS reported

assets, revenues and profits of $28.9 billion, $33.4 billion and $2.9 billion.

Therefore, with the new agreement signed between United States and China, the

industry observers wondered how the titanic struggle between FedEx and UPS would

develop, particularly for the investors in both firms. The issues are which firm was doing

better and what had been the impact of the intense competition between those two firms.

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2.0 QUESTIONS

2.1 QUESTION 1

What happened to FedEx and UPS’S stock price in early 2004? Why did they rise? Why did

one outpace the other?

According to the case, FedEx and UPS’s stock price rise steadily since the landmark

air-transportation agreement between United States and China that increases the number of

commercial cargo flights between the two countries. The agreement also allowed the

establishment of air-cargo hubs in China and landing rights for commercial airlines at any

available airport. Since UPS and FedEx are the only US all-cargo carriers, they were

permitted to serve the large Chinese market which then makes them to be the primary

beneficiaries of the landmark agreement.

Even though both of the companies’ stock price increases, FedEx outpaced UPS at a

rate nearly five times faster. This is because FedEx has the largest foreign presence in China

where they have 11 weekly flights which were almost twice of the UPS at 6 weekly Boeing

747 flights to China. The company also serves 220 Chinese cities and flew directly to

Beijing, Shenzhen, and Shanghai compared to UPS where they only serve nearly 200 cities

with direct flights only to Beijing and Shanghai. FedEx’s volumes in China had grown by

more than 50% between 2003 and 2004.

Besides, FedEx had virtually invented the customer logistical management and it was

widely perceived as innovative, entrepreneurial and an operational leader. However, it is

different with UPS where historically, they have a reputation for being big, bureaucratic and

an industry follower but recently, UPS also became an innovator and a tenacious adversary

where the company undergone a major overhaul of its image and was repositioning itself as a

leading provider of logistics and supply-chain management services.

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2.2 QUESTION 2

Why didn’t UPS create overnight delivery? How did FedEx get away with successfully

entering this market?

Based on the case study, UPS chose not to compete directly in the overnight delivery

market until 1982. Overnight delivery meaning that the delivery will be taken place on the

following day of shipment. For instances, if UPS made shipment on Monday, then the goods

will arrive on Tuesday. Therefore, it is believed that UPS chose not to enter into the overnight

delivery market due to the enormous cost of building an air fleet. Moreover, by doing an

overnight delivery it will go against UPS strategy of being the industry low-cost provider.

On the other hand, FedEx was able to successfully enter into the overnight delivery

market due to the strategy and large investment of capital made by Smith’s at the initial

stage of the business. According to the Smith’s strategy, FedEx will purchase their own plane

to transport packages. This strategy gives FedEx a competitive advantage over its competitors

since the other company is using cargo space that is available on passenger airlines.

Furthermore, FedEx success is also due to its hub-and-spoke distribution pattern as it

allows FedEx to serve more location faster and at a cheaper cost than its competitors. FedEx

also continue to expand their air-delivery business by acquiring more trucks and aircraft,

expanding services and raising capital.

2.3 QUESTION 3

How have UPS and FedEx performed financially?

In order to measure the financial performances of UPS and FedEx, we have decided

to compare the financial ratios of both companies. Financial ratios are the relationships

determined from a firm’s financial information and used for comparison purposes. There are

five categories of financial ratios that we are going to identify in this case which are Activity

Analysis, Liquidity Analysis, Long-Term Solvency Analysis, Profitability Analysis and

Growth Analysis.

1. Activity Analysis

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Activity Analysis measures the efficiency of UPS and FedEx in utilizing their assets. In this

section, we decided to compare the total asset turnover of UPS and FedEx from 1992 to 2003.

Total asset turnover is measured by dividing the sales with total asset.

Table 3.1 shows the total asset turnover for UPS and FedEx.

‘92 ‘93 ‘94 ‘95 ‘96 ‘97 ‘98 ‘99 ‘00 ‘01 ‘02 ‘03

UPS 1.83 1.86 1.75 1.66 1.50 1.41 1.45 1.17 1.37 1.24 1.19 1.16

FedEx 1.38 1.35 1.42 1.46 1.53 1.51 1.64 1.58 1.58 1.47 1.49 1.46

Diagram 3.1 shows the trend in total asset turnover for UPS and FedEx

2. Liquidity Analysis

In Liquidity Analysis, we are going to analyse the companies’ ability to pay their debts over

the short run without undue stress. In this section, we are going to focus on current ratio and

defensive interval.

a) Current Ratio

Current ratio is calculated by dividing the current assets with current liabilities. To a short-

term creditor, the higher the current ratio, the better. Meanwhile, to the firm, a high current

ratio indicates liquidity, but, it also may indicate an inefficient use of cash and other short-

term assets.

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Table 3.2 shows the current ratio for UPS and FedEx from 1992 to 2003.

‘92 ‘93 ‘94 ‘95 ‘96 ‘97 ‘98 ‘99 ‘00 ‘01 ‘02 ‘03

UPS 1.03 1.00 1.04 1.09 1.35 1.32 1.46 2.65 1.58 1.64 1.57 1.79

FedEx 0.87 0.99 1.15 1.05 1.07 1.09 1.03 1.13 1.14 1.06 1.25 1.18

Diagram 3.2 shows the trend in current ratio for UPS and FedEx.

b) Defensive Interval

A defensive interval measure can be used to measure how long a company can

operate until it needs another round of financing if the company is facing a strike and cash

inflows began to dry up. It is measured by dividing the current assets with average daily

operating costs.

Table 3.2.1 shows the defensive interval for UPS and FedEx from 1992 to 2003.

‘92 ‘93 ‘94 ‘95 ‘96 ‘97 ‘98 ‘99 ‘00 ‘01 ‘02 ‘03

UPS 1.71 1.83 1.47 1.36 1.38 1.60 3.12 5.13 3.07 2.82 4.98 4.57

FedEx 0.70 0.78 0.91 0.92 0.68 0.72 0.80 0.92 0.94 0.87 0.92 1.02

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Diagram 3.2.1 shows the trend in defensive interval for UPS and FedEx.

3. Long-Term Solvency Analysis

Long-term solvency ratios measure the companies’ long-term ability to meet its

obligations. In this analysis, we are going to compare two commonly used measures in long-

term solvency analysis which are the debt-equity ratio and times interest earned.

a) Debt-Equity Ratio

The debt-equity ratio measures a company's financial leverage. It is calculated by

dividing a company's total liabilities by its stockholders' equity. This ratio determines how

much debt a company is using to finance its assets relative to the amount of value represented

in shareholders' equity.

Table 3.3 shows the debt-equity ratio for UPS and FedEx from 1992 to 2003.

‘92 ‘93 ‘94 ‘95 ‘96 ‘97 ‘98 ‘99 ‘00 ‘01 ‘02 ‘03

UPS 0.23 0.22 0.24 0.34 0.44 0.43 0.36 0.19 0.37 0.50 0.37 0.26

FedEx 1.24 1.21 0.95 0.70 0.52 0.51 0.41 0.29 0.37 0.36 0.28 0.28

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Diagram 3.3 shows the trend in debt-equity ratio for UPS and FedEx.

b) Times Interest Earned (TIE) ratio

TIE ratio is measured by diving the Earnings Before Interest and Taxes (EBIT) with

the interest. This ratio measures how well a company has its interest obligations covered, and

it is often called the interest coverage ratio.

Table 4.3.1 shows the TIE ratio for UPS and FedEx from 1992 to 2003.

‘92 ‘93 ‘94 ‘95 ‘96 ‘97 ‘98 ‘99 ‘00 ‘01 ‘02 ‘03

UPS 18.68 23.59 20.85 17.19 13.71 7.38 12.17 16.08 19.58 16.83 23.15 36.41

FedEx 1.36 1.82 2.92 3.73 4.31 5.06 6.42 7.78 7.83 6.58 6.98 10.51

Diagram 4.3.1 shows the trend in TIE ratio for UPS and FedEx.

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4. Profitability Analysis

Profitability Analysis is intended to measure how efficiently the companies use their assets

and manages their operations.

a) Profit Margin

Profit margin is calculated by dividing the net income with sales. It indicates how many

percent does a firm earns profit for every dollar in sales. For every companies, high profit

margin is always desirable, other things remain constant.

Table 3.4 shows the profit margin (%) for UPS and FedEx from 1992 to 2003.

‘92 ‘93 ‘94 ‘95 ‘96 ‘97 ‘98 ‘99 ‘00 ‘01 ‘02 ‘03

UPS 3.12 4.55 4.82 4.96 5.12 4.05 7.02 3.26 9.86 7.83 10.18 8.85

FedEx -1.51 0.69 2.41 3.17 3.00 3.14 3.17 3.76 3.77 2.98 3.45 3.69

Diagram 3.4 shows the trend in profit margin for UPS and FedEx.

b) Return on Assets (ROA)

ROA measures how much profit a firm generates for every dollar of assets. It is measured by

dividing the net income with total assets.

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Table 3.3.1 shows the ROA (%) of UPS and FedEx from 1992 to 2003.

‘92 ‘93 ‘94 ‘95 ‘96 ‘97 ‘98 ‘99 ‘00 ‘01 ‘02 ‘03

UPS 6.47 9.10 9.10 9.24 8.65 7.16 11.69 4.91 14.61 10.68 12.73 10.44

FedEx 1.63 4.38 6.45 7.08 6.75 6.51 6.94 7.33 7.32 5.74 6.38 6.30

Diagram 3.3.1 shows the trend in ROA of UPS and FedEx.

c) Return on Total Equity (ROE)

ROE measures how much the shareholders will be fared during the year. It indicates how

many percent the shareholders will earn for every dollar in equity. ROE is calculated by

dividing the net income with average total equity.

Table 3.3.2 shows the ROE (%) of UPS and FedEx from 1992 to 2003.

‘92 ‘93 ‘94 ‘95 ‘96 ‘97 ‘98 ‘99 ‘00 ‘01 ‘02 ‘03

UPS 13.87 20.53 20.30 20.25 19.42 14.93 24.27 7.08 30.14 23.14 25.55 19.51

FedEx -7.20 3.22 10.62 13.25 11.95 12.19 12.70 13.54 14.38 9.90 10.85 11.39

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Diagram 3.3.2 shows the trend in ROE for UPS and FedEx.

5. Growth Analysis

Growth Analysis tells us how fast the company is growing. There are two measures

that we are going to use to measure the growth rate of UPS and FedEx which are sales and

net income.

a) Sales

Sales is the term used for operating revenues and it is normally stated in terms of a

percentage growth from the previous year. It is important for companies to have high sales

growth rate as possible.

Table 3.5 shows the sales growth (%) in UPS and FedEx from 1992 to 2003.

’92-

‘93

’93-

‘94

’94-

‘95

’95-

‘96

’96-

‘97

’97-

‘98

’98-

‘99

’99-

‘00

’00-

‘01

’01-

‘02

’02-

‘03

UPS 7.65 10.08 7.51 6.29 0.40 10.37 9.13 10.05 2.94 2.04 7.08

FedEx 3.42 8.60 10.76 9.39 12.13 37.79 5.67 8.84 7.52 4.98 9.12

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Diagram 3.5 shows the trend in the sales growth in UPS and FedEx.

b) Net Income

The growth in net income is more important than in sales because net income tells the

investor how much money is left over after all the operating costs are subtracted from sales.

Table 3.5.1 shows the net income growth (%) in UPS and FedEx from 1992 to 2003.

’92-‘93 ’93-‘94 ’94-‘95 ’95-‘96 ’96-‘97 ’97-‘98 ’98-‘99 ’99-‘00 ’00-‘01 ’01-‘02 ’02-‘03

UPS 56.86 18.51 10.57 9.88 -20.68 91.53 -49.28 232.28 -18.23 32.64 -8.93

FedEx -147.34 279.4 45.61 3.42 17.37 39.26 25.51 9.03 -15.1 21.50 16.9

Diagram 3.5.1 shows the trend in the net income growth in UPS and FedEx.

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The analysis of the financial performances in UPS and FedEx from 1992 to 2003 can be

summarized as follows:

Financial Analysis UPS FedEx

1. Activity

(Total asset turnover)

UPS shows weakening

performance since 1992.

FedEx shows a gradually

better performance in

asset management.

2. Liquidity

(Current ratio and

defensive interval)

UPS shows better

performance in liquidity as

shown by higher rates in

both current ratio and

defensive interval than

FedEx.

FedEx shows weaker

performance in liquidity

than UPS.

3. Long-Term Solvency

(Debt-equity ratio and

TIE ratio)

UPS shows better

performance in solvency

through the gradual

improvement in the debt-

equity ratio and higher rates

in TIE ratio than FedEx.

FedEx declines rapidly in

debt-equity ratio and

gradually increasing in TIE

ratio, but, still it shows low

performance than UPS.

4. Profitability

(Profit margin, ROA

and ROE)

UPS consistently beats

FedEx in profit margin,

ROA and ROE by showing

relatively higher percentage

than FedEx from 1992 to

2003.

FedEx shows gradually

positive improvements,

but, still lower than UPS.

5. Growth

(Sales growth and net

income growth)

UPS shows improvements in

growth, but, still below

FedEx.

FedEx shows better

performance in sales and

net income growth.

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2.4 QUESTION 4

What does the stock-price performance tell you?

The price to earnings (P/E) ratio is possibly the most studied of all the ratios. A stock

can go up in value without significant earnings increases, but the P/E ratio is what decides if

it can stay up. Without earnings to back up the price, a stock will eventually fall back down.

The reason for this is simple, a P/E ratio can be simplify as how long a stock will take to pay

back your investment if there is no change in the business.

The reason stocks tend to have high P/E ratios is that investors try to predict which

stocks will enjoy gradually larger earnings. An investor may buy a stock with a high P/E ratio

if he or she thinks it will double its earnings every year (shortening the payoff period

significantly). If this fails to happen, then the stock will fall back down to a more reasonable

P/E ratio. If the stock does manage to double earnings, then it will likely continue to trade at a

high P/E ratio.

The stock price performance to analyze FedEx and UPS using P/E ratio. Earnings-

per-share (EPS) is the most widely used ratio and communicates how much profit is

generated on a per-share basis while Price-Earnings (P/E) ratio conveys the market’s value of

a firm’s share relative to the earnings actually generated.

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EPS should be interpreted over time, and both FedEx and UPS have steadily

increasing EPS since 1992. Share price for both firms has risen steadily with UPS overtaking

FedEx following the IPO in 1999 as shown in the graph below. In comparing FedEx and

UPS’ P/E ratios, UPS has been slightly higher than FedEx since its IPO in 1999 as shown in

graph above. This is because UPS initiated a two-for-one stock split, every shareholder with

one stock is given an additional share whereby the company exchange each existing UPS

share for two Class A shares. The company then sold 109.4 million newly created Class B on

the New York Stock Exchange in an initial public offering (IPO) that raised $5.266 billion,

net of issuance cost. This increasing of stock price is due high demand among investor and it

drives up the price. Another reason is that stock split gives a signal to the market that the

company’s share price has been increasing and people assume this growth will continue in

the future, and again, lift demand and prices.

Another measure that can be used is the cumulative compound annual return (CCAR),

which shows the percentage gain from holding each company’s share. At year-end 2003, the

cumulative annual return for UPS and FedEx was 705.95% and 528.02%, respectively,

indicating that the return from holding UPS’s stock was nearly 200% more than FedEx’s for

the same period. While both firms exceed the S&P 500 index in this measure, UPS again

outperforms FedEx.

In general, the advantage of the aforementioned measures is that they are linked to the

market price of shares, which is relevant. Also, since a company with higher and more certain

earnings forecasts will have a higher P/E ratio, this measure is risk-adjusted (Libby, et al.,

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2008). EPS is a fairly objective measure, as the ratio uses financial statement figures that can

be compared over time. The main disadvantages are that GAAP decisions influence the

earnings figure that drive these measures and that P/E ratios can be interpreted in various

ways, leading to inconsistencies.

2.5 QUESTION 5

If you had to vote for one of these two firms to enter the pantheon of excellent companies,

which one would you choose?

From the analysis, the best company to be chosen is UPS based on the ability of

historical performance in financial measurement. The UPS performs better providing

liquidity for managing cost and had strong potentials in generating profits to the companies.

To compare with the FedEx, UPS also enter the international market by following the

FedEx action to expand the industry, but the UPS’s growth was at the behind than FedEx

since they tried to maintain EVA to keep survive in the industry. FedEx was quite faster in

competing in global because they have non-financial advantage when enter China’s market

earlier and have market domination. Thus, FedEx’s share price had rocketed at a rate nearly

five times faster than UPS. The cost of transaction is quite cheaper since FedEx have invested

to the high technology and purchased own plane at the beginning of operation. However, the

FedEx had a problem in entering Europe and was forced to withdraw from the Europe. The

problems cause FedEx suffers more in financial.

Figure 5: EVA analysis for FedEx and UPS

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Though, the UPS enter China a bit late, they still catch up FedEx growth by starting

from lower revenue in the beginning. UPS maintained gaining positive Economics Value

Added (EVA) and reached peak in 2003 at $1,195 million. Indeed, UPS grew three times

better from the last year. It means that, the additional return on the economic capital after

deducting from the cost capital. By the other words, the company is independent in gaining

profit return.

We believe based on the previous performance of the UPS, it can go further in making

profit based on the long term advantage and strong financial status. Therefore, it will attract

shareholders and increase investor’s confident in providing external financing for this

industry. Therefore, it is encouraged for the UPS to do more research development in the

quality services of their product, so that they can compete in large industry in China. China

can be the best platform for the UPS because it offers good logistic and infrastructure as well

huge of population there.

3.0 CONCLUSION

In June 2004, the Chinese air transportation market has become accessible to FedEx and

UPS, and a decision must be made about which company to invest in. Financial performance

measures discussed reveal that UPS is superior, while the most important non-financial

measure of international growth potential is in favor of FedEx. In the past, FedEx has entered

new markets first and UPS has followed. When FedEx entered Europe, it was forced to

withdraw and suffered massive losses. UPS’ approach in international markets has resulted in

lower growth than FedEx, but highly positive EVA and MVA. While the share price response

was due to FedEx’s ability to dominate the Chinese market first, we believe that in the long

run, UPS will be successful at creating value, while FedEx will likely encounter the same

challenges that it faced in Europe. For these reasons, the recommendation is to invest in UPS

in order to create maximum shareholder value that is sustainable.