By Kunal Kapoor, CFA | 11-10-99 | 12:00 AM | Email Article
Finally, an IPO to get excited about.

The shares of United Parcel Service will begin trading today. The IPO is very different from the dot-com IPOs that have become the staple in recent months. UPS is a profitable company with a long-term record and a fabulous brand. Indeed, its brown trucks and uniformed delivery personnel have become ubiquitous parts of the American landscape.
Kunal Kapoor, CFA, is chief executive officer of Morningstar.

Not surprisingly, institutional investors lined up to get a piece of the action. The IPO priced at $50 a share, higher than the original estimate of $36 to $42 a share, because of high demand for the firm's stock. Based on the $50 price tag, UPS will have a market value of $60 billion--nearly five times the $13 billion market capitalization of FDX FDX, the parent company of Federal Express.

There are legitimate reasons for this gap. For the year to date through August 1999, FDX had revenues of approximately $13 billion, while UPS' revenues nearly hit $20 billion. More impressive, however, are UPS' high return on capital and high margins, which are about eight percentage points higher than those of FDX. They are the result of an expansive delivery network that increases the firm's economies of scale and allows it to minimize the delivery cost per package while reaching nearly every address in the U.S.

UPS is also a great e-commerce play. While FDX has stayed away from the residential-delivery business for the most part, UPS has aggressively courted this segment of the market. Indeed, during 1998's holiday season, more than half of all online sales were shipped via UPS. It's a statistic not lost on investors, who have pummeled FDX's stock in recent months precisely because it has fallen far behind UPS in the drive to win e-commerce-driven deliveries.

But as with most good things, UPS' shares are commanding a premium. Based on the IPO price, the stock sells at at close to 40 times its trailing 12-month earnings. That's nearly twice the multiple at which FDX sells for. In addition, it's likely that UPS' stock will move higher in the coming days amid the euphoria of its IPO. That means small investors, who were mostly shut out of the IPO, will have to pay a much steeper price.

What's a small investor to do? If you feel like UPS' stock is a must-own, and you're willing to hold it for the long run, chances are you'll do fine. UPS is a solid, well-run company that will be around for years after some of today's dot-com firm have fallen by the wayside. Be aware, though, that the firm is vulnerable to rising fuel prices and unionized labor. In the past, for example, earnings have suffered because pay-related disputes have led to the occasional strike.

As a result, it may be worthwhile to wait a little until the euphoria dies down before buying stock in UPS. Conversely, you might give serious thought to the much-cheaper shares of FDX. It's a fine company in its own right, and while it has some catching up to do, it's benefiting from many of the trends that are also helping UPS. FDX is also a favorite in some fine fund portfolios: It's owned by such standout offerings as Longleaf Partners LLPFX and Vanguard PrimeCap VPMCX.

Sentiment is such an important part of today's markets. After a federal judge sided with the government in the antitrust case against Microsoft MSFT, most Wall Street analysts barely blinked, confident that the case would be settled. That's surprising, though, because Wall Street types tend to dislike uncertainty and are easily spooked by litigation risk--just look at how shares of Philip Morris have been pummeled in recent years.

I'm also always amused by "price targets" set by Wall Street analysts. Earlier in 1999, for example, the analyst at CIBC Oppenheimer who follows Schwab SCH had a 12-month price target of $100 for the stock. Then the stock took a dive, temporarily dipping below $30. The analyst cut his price target to $40 but left his "strong buy" recommendation unchanged. Go figure. (Full disclosure: I own shares of Schwab.)
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Kunal Kapoor, CFA does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.
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