News Analysis date published New: 
Monday, July 23, 2012 - 11:30
New Date created: 
Monday, July 23, 2012 - 11:30
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Monday, July 23, 2012 - 11:30

Forget FedEx and UPS, Buy this Stock Instead

Monday, July 23, 2012 - 11:30am

When it comes to shipping packages, FedEx Corp. (NYSE: FDX) and United Parcel Service (NYSE: UPS) dominate the global landscape. FedEx handles roughly 8 million package deliveries every day and UPS can handle about double the packages, shipping daily, about 15.8 million parcels across the world. Their U.S. dominance is also unquestioned. The U.S. Postal Service is also a big player in the market, but loses billions of dollars every year trying to keep up with these two giants.

In addition to their leading market share, a secular trend supports their continued growth in the coming years: e-commerce, which keeps gaining share over traditional brick-and-mortar locations. Just look at how Amazon (Nasdaq: AMZN) is altering the retail landscape. Its growing influence may not have single handedly caused the demise of book retailer Borders bookstores or Circuit City, but certainly helped push them off the competitive cliff and into liquidation. Increased shopping activity from the Web means products are shipped from warehouses directly to consumers. This has reduced the need for middlemen distributors and has sent more business to FedEx and UPS. This trend is only expected to continue.

The only downside to running the world's largest package-delivery services is their fixed costs. It takes billions of dollars to buy additional trucks, airplanes and delivery centers to handle more packages and deliveries to customer doors. Last year, FedEx generated impressive operating cash flow of $4.8 billion, up more than 20% from $4 billion in 2010 . It also spent $4 billion in the form of capital expenditures to grow and maintain its operations, which was also up nearly 20% from the previous year. UPS is a much stronger capital allocator, but this is reflected in significantly higher numbers. The company's operating cash flow, for example, totaled $7.1 billion in 2011, an incredible 86% improvement from 2010. Capital expenditures reached $2 billion in 2011, up from $1.4 billion in 2010.

Both of these stocks seem like great investments with plenty of future growth, but they also sport extremely high valuations. UPS, for instance, trades at a forward price-to-earnings (P/E) ratio of close to 17 (based on a current share price of $78 and earnings expectations of $4.82 per share). FedEx's forward earnings multiple is more reasonable at nearly 13, based on its stock price of roughly $93 and projected earnings of $7.35 per share.

But what if I told you there is a way to play this nice growth trend in the shipping industry at a much more reasonable valuation?

Zebra Technologies (Nasdaq: ZBRA)
is a mid-cap company that specializes in helping shippers and manufacturers label and track their products while they are in transit. It does this through bar- code technology (the stripes of a zebra in the company's logo are meant to illustrate a bar code).

Zebra sells its clients the physical printers to create bar code labels, and more sophisticated radio frequency identification (RFID) chips and labels that can stand the extreme hot and cold temperatures of warehouses and more extreme climates. It also sells higher-margin printing supplies, software and services.

Last year, Zebra saw sales grow 10% to $983.5 million compared with the year-ago period. Net recurring income jumped 25% to $130.3 million. Cash flow, backing out a gain taken to sell one of its businesses, improved 6% to $148 million year-over-year. Capital expenditures were quite modest at $26.9 million for its free cash flow of $121 million, or about $2.25 per share.

Zebra's sales growth has been solid but slow in the past few years, due in good part to the recession. But cost controls and an improving economy have sent the operating profit margin to above 18% during the past 12 months. This has resulted in annual profit growth of 26% during the past five years. As a point of reference, UPS sports a profit margin of only 11.5%, while FedEx is significantly lower at 7.5%.

Risks to Consider: Despite the strong growth trends, firms operating in the packaging industry are economically sensitive. The vast majority of firms in the space suffered during the 2008 downturn, but have come back nicely. In this respect, a global recession is unlikely to hit again soon, and U.S. prospects continue to only improve.

Actions to Take -> Investing in Zebra Technologies allows investors to gain exposure to a growing global supply chain industry. The stock is more appealing than going with the obvious choices of FedEx and UPS. Zebra trades at a forward P/E of about 14 (based on current stock price of $35.5 and projected earnings of $2.57 per share), which falls in between the multiples of the two packaging giants.

In addition, Zebra has a much lower need to spend on annual capex. This is an important consideration and leaves room for share buybacks, which boost earnings per share. In each of the past two years, Zebra has repurchased more than $100 million of its own stock to represent more than 10% of its current market capitalization of $1.8 billion.

Overall, Zebra's valuation compares favorably to FedEx and UPS, and its profit trends in recent years have been much stronger. The stock is likely to continue to grow in tandem with increased global shipping activity throughout the world, which is a secular trend that should continue well into the next decade. More important, I like the stock for its investment potential, since shareholders can see gains in the mid-teens as the company's profits expand at a double-digit clip.

Ryan Fuhrmann does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.