Is the Current Crisis Helping or Hurting UPS?
Lately, I've been buying more online and having it delivered to my home. Millions and millions of other consumers around the world are doing the same. So these should be banner days for delivery companies such as United Parcel Service Inc. (NYSE:UPS), right?
And they are--to some extent. The problem for the company is that residential delivery is just part of its business model. While the brown trucks are no doubt making more deliveries to homes, they are not dropping off and picking up parcels at commercial establishments as they did pre-pandemic.
When the company released its first-quarter 2020 results on April 28, the press release included this sentence in its opening paragraph: "The company's results were adversely affected by the disruption to customers from the global coronavirus pandemic."
That was for the first quarter and we should expect more of the same for the second quarter, now that April has gone by without a cessation of Covid-19 cases. Some states now are easing their lockdowns to allow more businesses to open, but there remain questions about how many consumers are willing to go shopping in brick-and-mortar stores. Recent polling suggests a majority of the public is still fearful of the virus and inclined to stay home.
The first-quarter report covered UPS's three segments: Domestic, International and Supply Chain and Freight.
Domestic: It introduced its commentary with these words: "The progression of stay-at-home restrictions instituted across the country as a result of coronavirus closed businesses and disrupted supply chains, resulting in an unprecedented shift in customer and product mix in the quarter." Overall, the segment faced "significant headwinds" as well as higher self-insurance accruals. Diluted earnings per share, adjusted, dropped from $1.39 per share in first-quarter 2019 to $1.15 this year.
International: Adjusted operating profit dropped from $612 million in the first quarter of last year to $558 million this year. Daily volume dropped 1.8% because of a slowdown in commercial deliveries, while the price per piece fell 0.5% because of currency rates. Some good news, though, came from UPS's China operations, where volume rebounded in March to offset declines in January and February.
Supply Chain and Freight: The company reported: "Revenue was negatively impacted by widespread reductions in global economic activity." In addition, it noted it was taking several initiatives to help customers and its financial performance when demand recovers; these include aircraft charters from Asia, more customer relationships in the health care sector and applying peak surcharges (presumably if demand comes rushing back at some point). Operating profit fell from $211 million in the same period last year to $158 million this year.
Given the unknowns it faces, UPS withdrew its earlier guidance for 2020. Turning to the variables under its control, the company is making several changes:
Capital expenditures will be cut by about $1 billion.
Share buybacks for this year will be suspended, reducing demand for cash by about $783 million.
Brian Newman, the chief financial officer, wrote, "We take a disciplined and balanced approach to capital allocation and are confident in our liquidity position including our commitments to capital management and dividends."
The issue of dividends is an interesting one. Among the "moderate warnings" provided by the GuruFocus system is this one: "If a company dividend payout ratio is too high, its dividend may not be sustainable. The dividend payout ratio of United Parcel Service Inc is 0.75, which seems too high." Yet it also shows the payout ratio has risen as high as 2.75 in the past 10 years, while the median over the same period was 0.63.
All this would suggest the dividend is relatively safe for the time being, assuming conditions don't deteriorate too much more. And its report that Chinese volume recovered in March, after rough months in January and February, suggests its business in Europe and North America may recover in the next few months.
For its competitor FedEx Inc. (NYSE:FDX), recent months have been even unkinder. Reporting on its third-quarter results (to Feb. 29), FedEx said its adjusted, diluted earnings per share was $1.41, well down from $3.03 a year ago. Among the problems were higher self-insurance accruals (as was the case with UPS), compensation issues, higher costs from expanded service offerings and "the loss of business from a large customer."
That lost customer was indeed a large one: Amazon.com (NASDAQ:AMZN). According to Forbes, Amazon told its vendors in mid-December they could no longer use FedEx for shipments to its Prime customers. While Amazon did not say why publicly, Forbes cited a third party that found FedEx's on-time delivery performance fell from 77.5% in 2018 to 68.3% in the same period of 2019 (UPS was also down, but not as severely, from 86% to 80%).
But there were a couple of bright spots for FedEx, including volume growth for FedEx Ground. Chief Financial Officer Mike Lenz announced the company was taking steps to ready itself for tougher times. He said, "To mitigate these near-term headwinds and position the company for future earnings growth, we are attacking costs throughout the company by managing capacity, retiring our oldest and least-efficient aircraft, integrating TNT Express, and lowering our residential delivery costs by having FedEx Ground deliver FedEx SmartPost and certain day-definite FedEx Express packages."
Returning to UPS, it is in a relatively strong position despite taking on more leverage since 2014:
Note that UPS's return on capital is more than 24% and roughly four times as high as its weighted average cost of capital.
UPS has 13 guru investors; Bill Gates (Trades, Portfolio) and the Gates Foundation Trust is the one with the largest position, followed by PRIMECAP Management (Trades, Portfolio) and the T Rowe Price Equity Income Fund (Trades, Portfolio). Institutional investors hold just under 36% of its shares, while insiders have just 0.3%.
Conclusion
While our perspective as consumers might suggest these are golden times for delivery companies like UPS, they are not. On balance, their experience so far has been on the negative side since residential deliveries have been more than offset by lost volume in other parts of their businesses.
UPS may hurt a little over the next quarter or two, depending on the Covid-19 crisis and our economic responses to it. It should have no problem weathering these storms and is positioned to do well for its shareholders as we transition back to normalcy.
For value investors, the keys to UPS likely will be the large and increasing debt load and lack of a discounted share price. This means few or no purchases now.
Disclosure: This article is only an introduction to the company and investors must do their own due diligence. I do not own shares in it and do not expect to buy any in the next 72 hours.
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This article first appeared on GuruFocus.
