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Karen Gibbs and Geoff Colvin Karen Gibbs Geoff Colvin Geoff Colvin Karen Gibbs
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Air date: Dec. 19, 2003
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UPS roundtable

KAREN GIBBS: UPS would probably feel like Santa visits every day except for a rather significant obstacle - Federal Express, one of the most formidable competitors in all of corporate America. Investors, just like customers, can choose between the two companies. Jennifer Ritter at Lehman Brothers and Donald Broughton from A.G. Edwards track the moves of both companies, and they both join us from New York. Donald, let me start with you. What about the competition, mainly FedEx?

DONALD BROUGHTON: Well, FedEx is a formidable competitor, but so is UPS. What's interesting to me about this market is you have two very strong competitors, both A students, if you will, and behaving like rational duopolies, and everyone else at best qualifies as a C student.

GIBBS: Is the pie, Donald, big enough for everybody?

BROUGHTON: Well, both of the companies have a profitable history, and it is the fastest growing part of the tangible goods flow. When you look at the tangible goods that flow through the economy, the low-value, high-density goods don't grow; they oscillate. They have a cycle, but they don't grow. The growth in the economy is in higher-value, lower-density goods, and that's what FedEx and UPS move.

GIBBS: Which company, Donald, would you be betting on?

BROUGHTON: Well, historically we've been much more bullish about the shares at FedEx. We currently have the shares of UPS rated sell. That's a comment, though, about the valuation of the stock, not a comment about the quality of the company.

GIBBS: Jennifer, is first place up in the air?

JENNIFER RITTER: Excuse me, is what up in the air?

GIBBS: First place in the freight delivery business, up in the air?

RITTER: Is first place up in the air?

GIBBS: Yes. Meaning is it open season? Can either one of these companies take the number one position?

RITTER: Yeah, I mean essentially FedEx began as an air carrier and UPS began as a ground carrier, and so both are taking share from the other in that express is moving into ground and probably taking some share from UPS, and UPS is doing the same in air, really just because each has a bigger base in the unit where they began.

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GIBBS: Well, let's look at our own two heavyweights here and our version of what we call the tale of the tape. When you look at the ground market share, UPS clearly dominates at 45% versus FedEx 16%. But air marketplace actually goes to FedEx with 40% versus 34% to UPS. On a daily package volume, UPS had 12 million packages move through there, 5.5 million for FedEx. But for me, to mail a 5-pound package from Owings Mills to my mother in Chicago on a 2-day basis, it costs $14.46 for UPS versus $11.75 for FedEx. Jennifer, what are these companies doing right?

RITTER: What they're doing right is maintaining a very, very profitable business. They are maybe causing you to use FedEx this year, and maybe next year UPS' prices will be lower for that exact same route. Maybe FedEx has a cost advantage for that route and that's why they can charge a lower price. Ultimately, though, I don't worry about them charging prices that are too low that would in the end hurt their margins because of it.

GIBBS: Donald, what can these two companies do to improve their business?

BROUGHTON: Well, I think the biggest competitors they're going to have, it's a mistake to concentrate too much on the domestic business and instead look at the international business. These companies can grab an ever-larger, dominant share of the world trade in Europe, in Asia, as well as import and export from the United States.

GIBBS: Donald, you talk about this global commerce. How important is that for these two companies?

BROUGHTON: Well, it's extremely important. I commented earlier that the fastest-growing part of the tangible goods flow is the high-value, low-density segment. I would tell you that when asked to place a bet on what the fastest-growing economy in the world was with the most reliable rate of growth, I'd be happy to say that it wasn't any one economy, but the economy of world trade. And when I look at companies like FedEx and UPS, I've got to tell you that they look like the gatekeepers of that world trade velocity, and I expect that world velocity of trade will continue to grow.

GIBBS: Jennifer, how important is the freight business to our U.S. economy?

RITTER: I think it's very important. If you look at our economy overall, most of the industries are moving to a just-in-time model. In order to do that in some plans, that's a 5-minute window. The parts need to be there within 5 minutes to keep the plan running on time, and only UPS and FedEx can get those goods there in time.

BROUGHTON: And it's important to understand why that is so important to us in competing with the rest of the world. An interesting study done by Kass Logistics, they've tracked how much we spend as an economy on distribution, logistics, to generate a dollar of GDP versus other countries. And what's extraordinary is that we spend less on distribution and logistics to generate a dollar of GDP - it's less than 10 cents - than any of the other major economies. That's really interesting when you consider that some of the economies we're competing for that title with are Japan and Great Britain islands. When you look at the vast geographical stretch of our country and realize that we spend less on distribution per dollar of GDP than these small island countries, that's quite an extraordinary statement. And it's due to the kind of operational prowess and just-in-time inventory methodologies that have been developed and enabled by companies like a FedEx and UPS.

GIBBS: Donald, does the freight business require a different type of management style? You know, UPS doesn't have a corporate jet or executive suites or even special parking spaces.

BROUGHTON: Well, they own a few jets, but they use them to move goods. There's certainly different styles among all these different companies, but I think, and I suspect Jennifer would agree, I prefer companies who are operational oriented first in this segment. Our space, the transportation segment, is actually littered with examples of people who've come in as financiers, for instance, and try to do roll ups and weren't born as operating engineers and operating managers. Certainly operating prowess can turn into also financial prowess, but I like them to be operators first.

RITTER: I followed several industries before, and the UPS and FedEx management teams are truly some of the best I've met. And when you ask about what kind of team you need to run an organization like UPS or FedEx, it's a strong team that knows, you know, where X, Y, and Z is at any given point in time. It's really an amazing feat to be able to get packages around the world in 24 hours, and clearly they've got a good team of people there, from the CEO on down to the branch manager over in Louisville, in order to accomplish what's a really difficult task.

BROUGHTON: Although there's difference in methodology, I would say that the style of UPS is they come at it as engineers first. They study things almost to death. And when they move forward, look out - they've got it figured out. FedEx certainly has operating engineer prowess as well, but they tend to be a little bit more risk oriented. Let's face it - they're still run by the CEO who started it all from scratch. And so they're a little less risk averse, if you will, a little more willing to take a chance. At times that has come back to haunt them, but it also tends to make them a little bit more aggressive and a little bit more apt to grow faster.

GIBBS: Does that mean that they are also a little more innovative when it comes to readapting to the situations?

BROUGHTON: I don't know if I'd call it a little more innovative as much as I would just simply say, I mean what I'm fond of saying is you've got two safecrackers who have different methods by which they get into the safe, but they both are successful.

RITTER: And both are sort of evolving the industry together. You know it's almost good that they have different management styles because they're making the industry a better place by having the one team that's somewhat conservative and the other team that's a little more aggressive.

BROUGHTON: Absolutely. They force each other to be better.

GIBBS: Jennifer, is it just a two-horse race or is there a dark horse, some other ones that we should be looking at coming up the road?

RITTER: Well, there is DHL Airborne Deutsche Post. Airborne currently has something like 1 or 2 percent market share here in the U.S. versus UPS, FedEx combined with something over 80 percent market share. Now that Airborne has been bought by DHL, there is the idea that DHL has a lot of money to throw into the U.S. market and could take over, could really take some market share from the two big players. It's not something we worry about in the near term. It's going to take an awfully long time to build the network to be strong enough to compete with UPS and FedEx, but it's clearly something we're not taking our eyes off. The other player out there is the Postal Service, and quite frankly, I don't know anyone that would seriously worry about them taking share from UPS and FedEx. They have been gaining market share from the postal service almost since the day they began.

BROUGHTON: Yeah, all you need to do is go to the local post office and stand in line for a few minutes before you realize that they're not a real competitive threat. I'd agree with Jennifer that DHL Airborne isn't a significant threat at this juncture, and I don't know that it ever really develops into one. You know, Americans love alternatives, and that means that it's possible after establishing the air express market, the establishment by FedEx, it was possible for UPS to come in and grab some share and grow share over time as it proved itself to be a reliable provider, and I think the same is true as FedEx has grown share and taken market on the ground from UPS. But after you have an alternative, the need for a third player becomes less compelling. And I think that it's going to be much more difficult for a third player, whether it be Airborne DHL or anyone else, to come in and be able to do what first UPS did in stealing air express market share throughout the '90s from FedEx and now what FedEx is doing on the ground to UPS, because after you have an additional alternative, the need for a third and fourth are just less attractive.

GIBBS: Donald, what about the labor issue? We've got a lot of people working at UPS. Is that their Achilles' heel?

BROUGHTON: I don't know if it's an Achilles' heel. I would argue that it's a great compliment to UPS' management and operating engineers that they run union labor and are able to provide their services as efficiently as they possibly do. I would argue that certainly in the United States, and possibly the world, they are the best managers of union employees. I've never seen union employees hustle as hard and fast as a UPS driver does.

GIBBS: Jennifer, you agree?

RITTER: Yeah, I would agree. You know, some might have thought the unions were an Achilles' heel to UPS last summer when they were renegotiating the contract and customers feared a strike, which is what happened the prior time a contract was renegotiated with the unions. That strike did not occur, and now we're seeing packages, or soon after the contract was signed, we saw packages come back to UPS, and they have continued to come back. So I might call it an Achilles' heel for six months or so, but clearly we're running on smooth waters until five years from now when we're ready to renegotiate again.

GIBBS: Jennifer, how did you send your packages this holiday season?

RITTER: Actually I did eToys, which sent by UPS. I also did Michael C. Fina, which did UPS. I did all but one of my Christmas shopping gifts online and was thrilled with the response. And quite frankly, I got free shipping on most of it.

GIBBS: Donald, how about you?

BROUGHTON: FedEx ground on all of it except a couple of catalogue items which predetermined how they were going to ship it to me.

GIBBS: And finally, do you have any disclosures you'd like to make, Donald?

BROUGHTON: I think they're already included. We don't have a banking relationship. We recommend selling the shares of UPS. We have a neutral rating, a hold on FedEx.

GIBBS: Jennifer, disclosures?

RITTER: I don't have any that I need to make. We have one over-weights on both UPS and FedEx.

GIBBS: Jennifer Ritter, Donald Broughton, thank you very much for joining us.

RITTER: Thank you.

BROUGHTON: Thank you.

Hot gifts

GEOFF COLVIN: So as the shopping season reaches its peak, what's in all those boxes? We asked Amazon.com and they said the hottest gifts for grownups this year are the Apple iPod, the coolest digital music player and

the Canon Power Shot digital camera. This may well be the first year digital cameras have outsold conventional film cameras.

"The Five People you Meet in Heaven" and "Let It Be Naked," a CD remix of the Beatles' 1978 album.

For the men on your list, you can buy what you've always bought but this year with a difference. The sudden, hot trend is loud stripes and checks. Loud shirts are nothing new. They've been making them on German streets for decades. You really haven't seen loud until you've stopped by Turnbull and Asser but they make shirts for Prince Charles. What's new is loud shirts have gone mass market. Some of the shirts are so loud they should come with earplugs.

(video package begins)

I went to Banana Republic to check out this trend up close or as close as I could bear and here's what I want to know, classic stuff, almost solid tie… and then I see this, it almost makes you dizzy, what's going on here.

MICHAEL FOUNTAS: Right. The rules of fashion.

COLVIN: That's a shirt that almost makes you dizzy, right? What's going on here?

FOUNTAS: The rules of fashion are out the window now, Geoff. Everything is out the weekend. We're going for different patterns and styles.

COLVIN: Is this stuff selling?

FOUNTAS: Oh, out of the door, we can't even keep it in the stores.

COLVIN: Look at this. What colors are in it?

FOUNTAS: It's a basic check pattern, but we are throwing two different colors at you it's visually appealing, you look at it and you almost get dizzy, and throw in the tie and you have checks and polka dots. Two things you'd never put together, but you look at it and you love it.

COLVIN: Any theory about why guys are buying this stuff now?

FOUNTAS: It's almost like a midlife crisis, they don't have to grow their goatees and buy their motorcycles anymore. They can get a great fashion piece and be the talk of the town. Every guy in would want to be them.

COLVIN: Okay let's see how some of this stuff actually looks

FOUNTAS: Perfect, lets go try it on.

COLVIN: Let's see how it looks. The first one. What do you think?

FOUNTAS: First off, how do you feel in it? That's the most important thing.

COLVIN: Well, I feel pretty good. You know, it's pretty bright. Especially when you get close to it and see the whole thing.

FOUNTAS: A little flashy in the color but you want to be seen, don't you? You want to stand out from the others?

COLVIN: Yeah, but you could put this on parolees and you'd always know where they were.

FOUNTAS: It's pretty bright, but you're not going to see this on Ted Koppel or Tom Brokaw.

COLVIN: That's for sure.

FOUNTAS: Let's go ahead and try on another one, alright, we'll see how you like it.

COLVIN: All right. Number two. The big checks may be an opportunity to play ticktacktoe with your date.

FOUNTAS: And the x's and o's could be your accessory.

COLVIN: If you look at this for a while it does start to move on you, doesn't it? You could hypnotize visitors.

FOUNTAS: Or viewers. They'll stick with the program, won't switch off.

COLVIN: And yes, customers were buying these shirts. This guy was back for more.

CUSTOMER: I think I'm going to get a striped red and sort of darker red shirt for work.

COLVIN: It's a little bright.

CUSTOMER: I've been wearing white shirts I think pretty much from time immemorial and I'm really struck by these shirts. I've been struck by these shirts and gotten more compliments on these shirts than anything I've worn in the last 10 years.

(video package ends)

Stovall interview

COLVIN: Those shirts are probably a fleeting fashion phenomenon. But we noticed businesses of the opposite kind are also doing well. Nothing is less fashionable than coal. It's been around 200 million years but coal companies have been booming, yet a lump of coal is not something you want in your stocking. As if it ever was. Maybe you should be wishing for copper or steel. Look at that. What in the world is going on? Well, Sam Stovall is Chief Investment Strategist for Standard and Poors. These are some of the unsexiest products on earth. Which ones should be attractive to investors?

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SAM STOVALL: I guess in 2004 boring can be beautiful. And our feeling is that the non-gold or non-precious metals look fairly attractive for the coming year, mainly because we're expecting strong earnings increases and so in the area of copper, steel, and we think there are some in aluminum, we think there are some good investment opportunities.

COLVIN: Is there some broad opportunity some should be seeing price increases now?

STOVALL: Well, yes, because we're seeing the growth in the US Economy as well as expected growth in worldwide companies, because these are multinational products because the dollar has been weakening, it makes them more attractive overseas and also because the cost of the production has been reduced, so these companies are able to improve their overall earnings.

COLVIN: You raise a couple of very good points because a lot of people think, for basic materials like this, foreign competition is inevitably going to be lower cost, so are these US Companies long term just not going to be able to make it?

STOVALL: Certainly not all of them. Our feeling is that only a couple that are low-cost producers, very high on the efficiency scale are likely to be survivors, but it actually would be helpful to the industry to have several of the lower margined or those companies on the fringe, have them just go out of business.

COLVIN: Let me ask you another big-picture question. These are sort of basic, grimy products, things people can touch and see and feel. Do you think investors are attracted to them because they got burned by technology companies they never could understand?

STOVALL: That's a possibility. But not that many people want to get all too familiar with copper, aluminum, steel, or even coal. But I guess the feeling is something they experience on a daily basis, whether it happens to be in your homes or cars. But, also, the feeling is you do have a better appreciation for how the valuations are likely to materialize over the next couple of years, how they typically are supposed to be valued and therefore where the opportunities lie.

COLVIN: Now, you don't like all the companies in these sectors, so which companies do you like specifically?

STOVALL: Well, specifically in aluminum we favor the major company, Alcoa.

The feeling is here's a company that is expected to show tremendous earnings growth and offer above market dividend rate and has fairly attractive price to earnings ratios. In the copper area we favor Phelps Dodge because of good earnings prospects, not a dividend player but one we think is trading at market multiples.

And finally Nucor and Steel Dynamics are companies in the steel industries that are again trading at market multiples that offer a minor dividend yield but also are expected to benefit from an earnings front because of an improved economy.

COLVIN: These stocks are all way up, but if you look at them over history, all the ones you've mentioned, have gone up and down within a range for years and years. So investors would like to know, how can they be sure when it's time to sell them?

STOVALL: Well, these comities are cyclical in nature, meaning they're not your long-term buy and hold, typically they go up but just as typically they come down as the economy itself tends to weaken. The feeling is you want to hold on to these issues as the economy has been improving for a while but you don't want to hold on to them until the recession is at hand.

COLVIN: And you want to spot the recession before anybody else, right?

STOVALL: That's right. If you start to see the defensive areas of the stock market improve, such as the beverages, food, tobacco, as well as health care and utilities, then you get a pretty good idea that maybe the end of this economic expansion is at hand.

COLVIN: Sam Stovall, thanks so much.

STOVALL: You're welcome.

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