UPS2

The latest trading update from UPS deserves a close look – and not just because the share price of the Atlanta-based behemoth fell almost $10 to $105 last week after it announced its fourth-quarter and year-end results.

On the one hand, I felt mildly disappointed as UPS released 2017 guidance based solely on non-GAAP figures.

On the other hand, this $95bn-market-cap company continued to record a very solid performance on an adjusted basis – which bodes well, I reckon, for trades in the business of moving goods worldwide, particularly in the burgeoning e-commerce space.

Annual earnings were impacted by one-off charges, but fundamentals remained strong – net leverage is negligible given the amount of core cash flows it churns out – so it is possible that investors overreacted, although core underlying profits were a touch light based on quarterly estimates from analysts.

That said, a solid pay-out ratio and a dividend yield in the region of 3% sound reassuring. In fact, aside from certain noticeable pension-related adjustments that weighed on its reported, unadjusted figures, operating trends were truly inspirational, in my view, especially considering the latest consumer spending figures from the US, where UPS turns over about three-quarters of its total revenue.

In short, the American consumer is still spending over the odds, based both on my personal expectations and given how the domestic purchases are financed, yet several elements suggest hard landing in 2017 and early 2018 as unlikely, although a soft patch for the global economy remains a distinct possibility.

Macro stuff

It goes without saying perhaps, but I’ll reiterate once more: transport executives ought to watch carefully how interest rates and oil prices behave in the near future. While trends for the black gold are unpredictable, oil prices may well stabilise around current levels for some time, while interest rates will likely continue to rise based on rising CPI figures, pundits argue.

It is my view, in this context, that oil prices could surge as fast as they could fall, while wild interest rates movements and the steepening of the yield curve in the US confirm that inflation forecasts are not completely out of whack with reality, although this remains a balancing act between expectations and action from central banks. In fact, if Federal Reserve hawks prevail, any monetary tightening could seriously harm the consumer and will have a subsequently depressive effect on the transport and logistics industry.

In order to assess the downside risk to the trades of UPS and its rivals, other key elements should be observed – how about salaries, for example?

On the day UPS reported its trading update, Forbes wrote that “US real wages rose 1.3% in 2016 – or 0.1%. Or nothing. Or many other numbers besides”.

To be sure, regionalisation of services and supply chains brings greater downside risk to global trades going forward – not only is the consumer king in this competitive market for volumes of transported goods, but delivery speed, accuracy in data gathering and storage and consumer behaviour are all tough to manage, and require serious funding.

That is why UPS is in a sweet spot as it continues to grow inorganically, while also investing top dollar in its core activities.

A threat?

Amazon has always been a threat – or is it? – but to my mind UPS has proved it knows how to handle the pressure. It has so far exploited its vast infrastructure network to profit from favourable trends in e-commerce, adapting swiftly to changing realities while risking relatively little shareholder money during the process.

A peak season is never easy to manage, but it coped well in December, having learned from its mistakes at a time when even Amazon struggled to keep up with rising volumes for certain air shipments, I heard.

(Please read my coverage on 4/11/2015, titled “UPS urgently needs to prepare for itself for an Amazon e-commerce attack”.)

Eye-catching

The first bullet point of its trading announcement read: “US domestic 4Q revenue climbs 6.3% driven by e-commerce.”

As if that was not enough to convince the bears, international export shipments soared 8.4% led by Asia and Europe, which was by no means a given in light of the severe strains in the supply chain throughout 2016, as proved by the demise of Hanjin Shipping and downward pressure on earnings for many transport and logistics companies.

Analysts did not digest certain reported figures from UPS, but investors who are bottom-fishing for value are keeping a close eye on the $100-$110 trading range, I gather, with consensus estimates pointing to fair value in the region of $114.

Non-GAAP figures were pretty good, however.

Still, there remains headline risk to certain figures. As MarketWatch recently reported, “even as the Securities and Exchange Commission steps up its efforts to make companies produce clean, easily understood earnings, companies are ignoring best-practice conventions in the way numbers are presented”.

Two last points: firstly, a strong US dollar is likely keep biting into earnings for at least in the first half of the presidential mandate; and secondly, all of the above comes with one big caveat. If UPS picks the wrong investment plan or partnership/deal of a certain size in the e-commerce field, its successful growth and income story could turn into disaster overnight, jeopardising shareholder value.

It has been careful in terms of corporate strategy so far, and that is paying dividends.

Based on how it has recently delivered, the odds are short it will prove the bears wrong once again in future quarters, also because smaller players are seeing their creditors – many of which have some serious problems with their shipping portfolios – tighten their purse strings.

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