Analysis: this week, an interims spectacular, starring UPS, Panalpina and DSV
Are three stars – UPS, Panalpina and DSV – about to shine in the transportation ...
“UPS is making great progress on our transformation initiatives to enhance profitable growth and improve operating leverage. We are confident that our strategies will position the company to provide improved value for customers and shareowners.” So said David Abney (pictured above), UPS chairman and chief executive, at its recent interim results.
UPS stock rocketed last week after the US-based behemoth maintained its position in a transport and logistics industry where only a few companies and their shares are performing according to their recent standards in this late phase of the business cycle.
Its half-year results were even better than on first inspection when compared with FedEx’s; while its shares price, which outperformed on its way up, has also been more resilient when under pressure, benefiting from a solid yield and a wise capital allocation strategy that is also the basis of its strength.
But what comes next, given a stock market rally that still leaves the price well below the previous records reached this year?
UPS has plenty of flexibility to release funds via M&A, higher dividends or larger buybacks, and will surely continue to use a mix of these three tools to deliver value to its shareholders, but also prioritising heavy capital expenditures.
As far as deal-making is concerned, for example, it could easily win a takeover battle with FedEx for Royal Mail in the UK, whose value has again plunged to levels that make it a very attractive takeover target. With a market cap of £4.7bn ($6.2bn), Royal Mail would likely cost $8bn or so (8% of UPS’s market value), which is do-able financially.
UPS could use debt to finance the purchase – although its net leverage is rising, it remains in the comfort zone, and it would hardly be problematic if $4bn of additional acquistion-related debt was added to the balance sheet.
As a reference, that price tag is roughly double the amount of free cash flow the American company generated in just the first half of this year, when free cash flow surged to $4.4bn, driven primarily by transformation initiatives that were beneficial to working capital. As a result, last week UPS raised its free cash flow guidance to $5bn, which implies a respectable forward free cash flow yield of 5% annually.
However, Royal Mail is not the most suitable target for UPS – and not only due to its size. It doesn’t offer the service assets that UPS is after.
If UPS was serious about a jumbo deal, XPO Logistics (market cap $11bn) would make more sense, given its geographical mix, underlying business lines and share price weakness (17% below its record highs) that has in recent days again spurred takeover rumours among traders.
Incidentally, at about $95, the shares of XPO currently trade where they changed hands before speculations concerning a possible takeover by Home Depot emerged in December.
However, XPO would also likely be dilutive in terms of underlying margins and, operationally, UPS has other ideas.
Deal, what deal?
At the end of last year, UPS acquired Sandler & Travis Trade Advisory Services, a relatively well-managed company, for an undisclosed amount. This was a bolt-on acquisition, thanks to which the acquirer consolidated what it claimed was the world’s largest independent provider of global trade management services.
UPS strives to be the global customs broker of choice that could “enhance customer experience” while bolstering trade and “customs-related information services infrastructure”. Which means it will likely continue to try to add value to its services with focus on compliance with government and industry laws, as well as rules and best practices that favour the movement of goods across borders.
UPS acknowledges it needs to buy and build solutions for its clients, specifically including “duty drawback, regulatory compliance, rules of origin determination, harmonised tariff schedule classification, export control classification, order management, free-trade agreement qualification and verification and more”. These are all services designed to free resources for its customers while targeting, in its own words, supply chain velocity.
Elsewhere, there has been talk in the marketplace that UPS might eye European freight forwarders that have relevant share in air freight activities. Viable takeover options are scarce, although the usual suspects – Hellmann and Dachser – could help it challenge market leaders DP-DHL GFF and Kuehne + Nagel.
Still, its underlying operating profits can do without sizeable freight forwarding activities.
In recent years, UPS has added over $7bn of consolidated sales to its books, but its operating income performance has been subdued, as I pointed out earlier this year, one reason being heavier investment and costs diluting returns.
So, it will be unsurprising if UPS continues to focus on alternative capital deployment levers rather than undertaking large deals.
In the recent past, its largest acquisition on record – the $1.8bn purchase of Coyote Logistics – “albeit successful, has left management with mixed feelings”, according to one UPS insider, while the departure of Coyote’s co-founder, Jeff Silver, this year was not unexpected but testifies to the difficulty of executing M&A according to original schedules.
As it continues to pay attention to pension contributions, UPS remains cautious on M&A, but will likely continue to boost earnings per share by buying back its own stock, which would also propel its dividend per share at a time when chief rival FedEx has become more aggressive in terms of payouts.
Year to date, UPS dividends have increased by 10% to $1.6bn and share repurchases stood at $511m. By comparison, last year it invested $5.2bn in capital expenditures (capex is now projected at $6.5bn-$7bn this year), paid $2.9bn in dividends and repurchased shares to the tune of $1.8bn.
Given its beta, a conservative payout ratio and relatively lowly trading multiples, the bulls are entitled to believe there could be upside in the second half, regardless of M&A action which might remain subdued for transport integrators, unless true value opportunities arise.