The Battle for Value

Andrew Hall
Yo Yo Ma
Jerry Seinfeld
Team One
22nd May 2008

Contents
Objectives

Management Summary

Sustainable Competitive Advantage

Enabling Factors..................................................................................................... 1
Inhibiting Factors.................................................................................................... 2
Conclusion.............................................................................................................. 2
Interpretation of the 14% Increase in FedExs Market Value of Equity

FedEx and UPS share price and liberalized air cargo routes between the U.S. and
China...................................................................................................................... 3
Conclusion.............................................................................................................. 3
UPS and FedEx Performance Since Early 1990s

Financial Statement Analysis.................................................................................. 3

Ratio Analysis......................................................................................................... 3
Activity Ratios.................................................................................................... 3
Liquidity Ratios................................................................................................... 4
Profitability Ratios.............................................................................................. 5
Growth............................................................................................................... 5
Stock-Price Performance......................................................................................... 6
Economic Value Added........................................................................................... 6
Market Value Added................................................................................................ 7
Conclusion.............................................................................................................. 7
Excellence in Business

Conclusion.............................................................................................................. 7
Appendices 7

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Objectives
This report seeks to answer the following four questions about UPS and FedEx:
1. What are the enabling and inhibiting factors facing the two firms as they
pursue their goals? Do you think that either firm can attain a sustainable
competitive advantage in this business?
2. Why did FedExs stock price outstrip UPSs during the initiation of talks over
liberalized air cargo routes between the U.S. and China? Assuming a perfectly
efficient stock market, how might one interpret a 14% increase in FedExs
market value of equity?
3. How have FedEx and UPS performed since the early 1990s? Which firm is
doing better? Discuss the insights you derived from the two firms financial
statements, financial ratios, stock-price performance, and economic profit
(economic value added or EVA).
4. If you had to identify one of those companies as excellent, which company
would you choose? On what basis did you make your decision? More
generally, what is excellence in business?

Management Summary
The enabling factors for the two firms are economies of scale, technological and
operational excellence and market dominance. The inhibiting factor for FedEx is
financial weakness; for UPS it was the culture of resting on its laurels. UPS has
improved its culture and is mastering technology and operations. FedEx needs to
address profitability and thereby address its financial weakness. UPS is getting
close to having a sustainable competitive advantage in the business.
FedExs stock price outstripped UPSs during the initiation of talks over liberalized
air cargo routes between the U.S. and China because the market viewed the
increased cash flows to FedEx as being a higher percentage increase than would be
the increased cash flows to UPS and then impounded the revised estimates of the
cash flows into the share price.
UPS is doing much better than FedEx financially. FedEx is growing faster than UPS
and is sacrificing profitability for growth.
UPS is the firm that I would identify as excellent, based upon its financial
performance and its growing operational effectiveness. Excellence in business is to
perform be excellent in all of the dimensions of a business: Human Resource
Management; Operations Management; Information Technology Management,
Marketing and Financial Management.

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Sustainable Competitive Advantage

Enabling Factors
FedEx entered the market when it was deregulated. Further deregulation might
lower the barriers to entry and allow new competitors. FedExs innovations in using
their own planes and a hub and spoke design for their network allowed them to
break into the market and innovation is a way of maintaining barriers to entry in the
market.
FedExs operational excellence through the use of Total Quality Management,
Technology and flawless execution is a barrier to the entry of competitors and this
allowed them to see off competition from USPS. Operational excellence also allows
them to be the lowest cost competitor and to post smaller price increases than UPS.
Employee participation and a non union environment give FedEx advantages over
UPS. Finally their strength in the Air Express Market gives them economies of
scale in this business and their heavy investment in Asia mean that they are better
placed than UPS to take advantage of the additional flights to be made available by
the new agreement.
In a market characterized by economies of scale, UPS size and strength in all
sectors give it economies of scale. UPS also has tremendous financial strength,
enjoying a AAA bond rating and better financials generally, see below, than FedEx.
Their financial strength enables them to price cut to establish market share and to
deter competitors. UPS has also invested in technology and process to allow good
operational performance and deter competitors.

Inhibiting Factors
The main general factors inhibiting entry into this market are Economies of Scale
and the presence of UPS and FedEx. While there is some competition, Emery Air
Freight and USPS, Emery does not have the scale to compete effectively and USPS is
unable to master the technology innovations or the operational excellence of either
UPS or FedEx.
The factors inhibiting FedEx are its relatively poor financial strength, evidenced by
its BBB bond rating; its withdrawal from the European market which suggests that
operational excellence is not the only criterion for success, and its concentration on
one segment of the market Air Express.
The factors which were inhibiting UPS success were its size and its age and signs of
complacency and a tendency towards resting on its laurels. In this respect the
arrival of FedEx in the market place has been good for UPS which has been forced to
respond with innovation and operational improvements of its own.

Conclusion
Both UPS and FedEx have the economies of scale needed to be fierce competitors in
this market. Both have sustainable competitive advantages, FedEx needs to
develop financial strength to maintain and improve its position.

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Interpretation of the 14% Increase in FedExs Market

Value of Equity
Under conditions of weak efficiency, a market is efficient if it factors past prices and
trading volume into the stock price and neither of these factors would explain the
14% increase in FedExs market value of equity.
Under semi-strong market efficiency, in addition to prices and trading volume, the
market is efficient if it factors analysts recommendations and financial statement
analysis into the stock price. No historical analysis of the financial statements of
FedEx is going to explain the 14% increase in FedExs market value of equity.
Strong market efficiency assumes that all publicly known information as well as
insider information is factored into the stock price. In this case, news of the
initiation of talks on liberalization of air cargo routes between the U.S. and China will
have been analyzed to identify the likely impacts on the future cash flows from both
FedEx and UPS. The 14% increase should reflect the markets assessment of the
present value of the incremental cash flows to FedEx that are likely to be derived
from the liberalization of air cargo routes between the U.S. and China.

FedEx and UPS share price and liberalized air cargo routes
between the U.S. and China
The agreement allows for five times as many commercial cargo flights overall, to
and from any airport in either country. With Air Cargo expanding currently at 30% a
year and with the expectation that this growth rate will continue for the next 5
years there are plenty of opportunities for UPS and FedEx to benefit.
FedEx currently has 11 flights a week and services 220 cities in China and has been
experiencing a 50% per annum volume growth in business in China. It has invested
heavily in Asia and so it is very well placed to take advantage of the liberalization.
UPS currently has 6 flights a week and services 200 cities in China and it is less well
established on the ground and therefore potentially less well able to take advantage
of the opportunity that liberalization of the market represents.
With one hundred flights a week up for grabs, however, it may be the more
financially able firm that will be able to finance the additions to the fleet of cargo
aircraft that will be needed. In this respect UPS is better placed. The fact that UPS
stock price percentage increase was not as great as that for FedEx may reflect the
differences in scale between the companies. Adding $100 in value to a $700
company adds 14.2% adding $100 to a $1,100 company adds 9.1%

Conclusion
The stock price is the PV of future cash flows to the stock. News which suggests
that the cash flows will be greater than previously thought will, in general, increase
the stock price.
Market expects liberalization to increase the PV of FedExs future cash flows by a
greater percentage than the increase in UPSs future cash flows

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UPS and FedEx Performance Since Early 1990s

Financial Statement Analysis
Financial statement analysis allows us to identify trends and to see the absolute size
of the business. The disadvantages of financial statement analysis include the fact
that financial statements are historic rather than predictive, the values are Book
Values rather than Market Values and they are based on the Generally Accepted
Accounting Principles (GAAP) which allow, in practice, for a fair degree of latitude.

Ratio Analysis
Ratio Analysis allows scale to be removed from the analysis and for comparison with
other similar firms. Ratio analysis suffers from all the problems of Financial
Statement Analysis, generally, since ratio analysis is usually based on financial
statements. Where market values are available they should be incorporated into
the calculation of ratios.
Activity Ratios
The activity ratios for FedEx are improving as those for UPS weakening
Average days receivables outstanding are fairly constant for FedEx from 1992 to
2003 while the average days receivables for UPS are increasing see Figure 1. One
explanation might be that UPS are competing on credit terms?
Figure 1

UPS has more working capital than FedEx. FedExs fixed asset turnover is
marginally higher than that of UPS. FedExs total asset turnover is higher than UPS
total asset turnover see Figure 2 This might point to FedEx making more use
than UPS of leasing or rental of equipment.

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Figure 2

Liquidity Ratios
UPS is significantly more liquid than FedEx as is evidenced by the Current Ratios
see Figure 3
Figure 3

Profitability Ratios
UPS is more profitable than FedEx on every measure including the net profit margin
shown in Figure 4.
Figure 4

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Growth
FedEx is growing more strongly than UPS on every measure other than Earnings per
Share (EPS). This can be attributed in part to the effects of the strike at UPS in
August 1997.
Figure 5

On earnings per share, UPS grew more significantly more strongly than FedEx
between 1999 and 2003 although FedExs growth in EPS was greater than that for
UPS between 1993 and 2003 see Figure 6.
Figure 6

Earnings Per Share

Compound Annual Growth Rate

1993-2003

1999-2003

UPS

13.89%

34.30%

FedEx

27.54%

6.98%

So, UPS is performing significantly better in the generation of earnings per share
and this is reflected in the longer term stock-price performance of UPS

Stock-Price Performance
Fed Ex saw a 22% gain compared to UPS 14% gain between June 2003 and June
2004. In the longer term, UPS has given stock holders better returns 551%
between 1993 and 2003 as compared with FedExs stock holder returns of 373%
for the same time period Case Exhibit 8. Both have performed very much better
than the S&P 500 index which showed cumulative compound annual returns of
155% in that period.

UPS
FedEx

1993
9.25
10.19

2003
74.55
63.98

CAGR
23.2%
20.2%

Formula
=RATE(10,0,-9.25,74.55,0,0.1)
=RATE(10,0,-10.19,63.98,0,0.1)

Some of the difference in the returns is reflected in the growth in the share price,
which was 23.2% per annum compounding annually for UPS between 1993 and
2003, and 20.2% for FedEx. In addition, UPS paid cash dividends where FedEx did
not.
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Economic Value Added

According to Case Exhibit 9, FedEx destroyed value each year from 1992 to 2002
and created $170 million of value in 2003 for a cumulative loss in value of $2,252
between 1992 and 2003. UPS also destroyed value between 1992 and 1996, but it
created value between 1997 and 2003 Case Exhibit 10. Figure 7 shows the annual
EVA for each firm.
Figure 7

Economic Value Added suffers from a number of weaknesses: it relies on GAAP and
accounting values and so it is a historic, rather than a predictive measurement. It
ignores strategic option values that derive from competencies such as the mastery
of special skills and technologies, and the established presence in markets.

Market Value Added

Market Value Added is calculated by subtracting the book value of the firms capital
from the market value of the firms capital and measures the markets perceptions
of the firms value added. UPS has been much more successful in creating Market
Value than FedEx, particularly since the strike in 1997, as can be seen from Figure 8
which shows the annual Market Value Added amounts for FedEx, from Case Exhibit
9, and for UPS, from Case Exhibit 10.
Figure 8

Conclusion
UPS financial performance is excellent and stronger, in most areas, than FedExs
financial performance. UPS. Both have performed better than the S&P 500 index.
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The Economic Value Added by UPS exceeds the EVA from FedEx, but the Market
Value Added for each is positive, because the market is predictive, valuing the firm
on future cash flow expectations rather than historical values.

Excellence in Business
UPS is financially excellent and it is achieving operational excellence to become a
truly excellent business. FedEx entered the market after UPS and has been very
successful, growing strongly to become second only to UPS in the market. FedExs
operational excellence is yet to be matched with financial excellence although
FedExs finances are improving.

Conclusion
On balance one has to favor UPS, although one should not count FedEx out.

Appendices
None

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