The market took a dim view of the recent results from United Parcel Service (NYSE: UPS), but there are reasons to believe it was a harsh judgment. In fact, UPS demonstrated progress on a number of initiatives, and little has changed with the investment proposition. In other words, if you liked UPS stock before the earnings report, there wasn't much in the results to change that view. Let's look at developments and why the market is beating up UPS unfairly.
UPS disappoints the market
The first-quarter results were lighter than analysts expected in terms of revenue and earnings per share (EPS). It gets worse. The second-quarter guidance for EPS growth to be flat against the same period last year left investors unimpressed. And it raised questions as to whether management was wise to reiterate full-year guidance for adjusted EPS of $7.45 to $7.75.
Moreover, total adjusted operating profit declined in the first quarter, with only the smallest segment (supply chain & freight) reporting a significant increase in profit. Is it time to throw in the towel?
|UPS Segment|| |
First Quarter 2019 Adjusted Operating Profit
First Quarter 2018 Adjusted Operating Profit
YOY Growth (Decline)
U.S. domestic package
Supply chain & freight
Data source: UPS. YOY=year over year.
Why the market is being harsh
UPS certainly has work to do to meet its earnings expectations -- missing first-quarter expectations and then guiding toward flat earnings for the second quarter is never a good start. But investors need to put matters into context. There are five considerations:
First, UPS took a hit from unexpectedly poor winter weather in the quarter. Management said the weather reduced operating profit by $80 million, operating margin by 70 basis points, and EPS by $0.07. Adding these figures back gives 5.1% growth in adjusted year-over-year operating profit, and would lead to adjusted EPS of $1.46, versus the figure of $1.39 in the quarter.
Second, the EPS guidance for the second quarter is hurt by planned pension financing costs. In fact, UPS management is guiding toward operating profit growth in the mid-single digits, but adjusted EPS is set to be flat due to the financing costs.
Third, as CFO Richard Peretz reminded investors, "2019 is a year of investments in our network and executing our strategies to improve operating cost and deliver higher quality revenue growth despite uncertain conditions." As such, UPS plans to open "30% of our new capacity for 2019 within the second quarter" according to Peretz. This will lead to extra expenses in the second quarter, which will constrain profit growth.
UPS is investing heavily in expanding and modernizing its network. Image source: Getty Images.
Fourth, Peretz's guidance for the third quarter -- for EPS around 28% of the full-year guidance midpoint -- implies earnings of $2.13 per share. That would represent year-over-year growth of 17%. In other words, UPS' growth is set to significantly improve in the coming quarters.
Fifth, management's full-year outlook continues to call for operating-profit growth in all three segments, up by low double digits, and free cash flow (FCF) in the range of $3.5 billion to $4 billion. The midpoint of that would put UPS on a forward price-to-FCF multiple of 23.4. That's not a bad multiple for a company in the middle of a period of heavy capital expenditures.
What it means to investors
There are question marks around UPS' guidance. After all, losing $0.07 of EPS from the weather in the first-quarter will put some pressure on full-year guidance for $7.45 to $7.75. In addition, UPS still has to demonstrate that it can expand margin and e-commerce related volumes. And investors and analysts are still waiting for management to indicate when the elevated levels of capital spending will fall, so they can price in estimates for long-term FCF generation.
That said, it's not rational to sell a stock based on poor weather in one quarter, or because the company is investing heavily to support future growth. Moreover, the long-term questions were known about before the last earnings report and were unlikely to be resolved in one quarter.
Putting it all together, the market appears to have overreacted to the headline numbers and guidance. If you were bullish on UPS stock before the earnings report, then it's probably a good idea to see the post-earnings dip as a buying opportunity.
More From The Motley Fool
- 10 Best Stocks to Buy Today
- The $16,728 Social Security Bonus You Cannot Afford to Miss
- 20 of the Top Stocks to Buy (Including the Two Every Investor Should Own)
- What Is an ETF?
- 5 Recession-Proof Stocks
- How to Beat the Market