Courier service providers incur high costs for running their operations. They require a large amount of capital to build and efficiently operate their huge networks. Another major capital investment is buying airplanes to maintain their own fleet. Being a labor-intensive industry, courier companies also have high labor costs. United Parcel Service (UPS) spends about 5% to 6% of revenues on labor, while FedEx (FDX) spends about 3.5% to 4% on labor.
Also, both these companies have grown through the inorganic route. Acquisitions also require a substantial amount of capital. As a result, companies in the courier service industry have resorted to funding part of their capital requirements with debt.
High leverage often results in reduced return on invested capital (or ROIC). ROIC measures the returns the company generates on the total capital invested in the business.
As can be seen in the chart above, ROIC for the courier industry has remained in the range of 10% to 13% for the last 11 quarters. However, it has continuously declined in the last four quarters, from 12.44% in 2Q14 to 10.49% in 1Q15.
UPS versus FDX
UPS is the bigger giant of the two. In 2014, UPS clocked revenues of $58.2 billion as compared to FedEx’s (FDX) $47.5 billion. UPS also enjoys higher margins than FDX. While there is a difference of only 1% in the companies’ EBITDA margins, the difference in operating margins is 3% and the difference in net margins is 2%. This is despite UPS having a higher debt-to-EBITDA ratio as compared to FDX.
High leverage is also the reason for the higher return on equity (or ROE) enjoyed by UPS. However, adjusted for operating leases, FDX has higher capital commitments as compared to UPS. As can be seen from the above chart, adjusted for operating leases, FDX’s debt-to-EBITDA of 2.96 is significantly higher than UPX’s 1.86.