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Like all listed US companies, UPS is obsessed with rising earnings per share (EPS), and there is little doubt that to achieve a higher level of profitability its B2C strategy in the e-commerce arena will play a key role.
Transport and logistics services are changing, as is the demand for them, and UPS’s management team is adamant it is doing everything necessary to stay ahead of the competition. It’s still early days to assess their claims, but its current financial performance leaves little to the imagination.
“UPS continued its positive momentum with the third consecutive quarter of improved growth in earnings per share,” chief executive David Abney told analysts following the release of its third-quarter results last week.
EPS trends deserve attention, but how EPS growth is achieved is equally important. UPS generated $4.6bn of free cash flow during the nine months ended September 30, paid $1.9bn in dividends and repurchased 20 million shares, spending about $2bn.
Third-quarter EPS rose 5.3% year on year – that’s an eye-catching number.
However, the calculation of EPS in the third quarter, as well as in the nine months, based on the total number of shares outstanding one year earlier, indicates that EPS growth would have been two full percentage points lower than reported, according to my calculations.
If I am right, each percentage point of EPS growth cost UPS $1bn – which is a lot, for two reasons: first, its stock price is flat over the last 12 months; second, surging competition in the e-commerce field poses a market share threat.
UPS’s performance on the stock market would have been worse without buyback. However, the $2bn bill, headed “financial engineering”, yielded a rather disappointing result.
At 19 times forward earnings, UPS shares trade only $10 away from a 52-week, all-time high of $114.4, so it will have to pay much more than the average price of $100 a share that it paid over the last year if it aims to shore up its valuation in 2016.
The problem is that larger buybacks could affect a rich dividend policy, and UPS is very unlikely to take any risks here. Dividends per share have risen from $0.28 in 2000 to $2.68 in 2014, and are expected to hit 2.92 this year, all of which implies a respectable compound annual growth rate of 17% over the last 15 years.
Elsewhere in its Q3 results:
In case you have missed our recent article on “Amazon Transportation & Logistics”, and how a so-called ATL unit could earn Amazon some $5bn a year, here’s an excerpt: “Amazon’s entrance into the freight business could take place in any one of three sectors: the US domestic parcel delivery sector, currently dominated by FedEx, UPS, DHL and the US Postal Service; freight forwarding; or contract logistics.”
E-commerce has continued to expand at UPS, Mr Abney told analysts, even though a strong dollar contributed to lower industrial production growth and softer exports. Global GDP projections for the second half of the year “have come down” in leading European markets, including Germany, Poland and the UK, while “Asia has also come down slightly, primarily influenced by lower China output”.
Chief commercial officer Alan Gershenhorn added that package sizes continued “changing due to the e-commerce trends”.
As a result, UPS has adjusted prices to ensure they are aligned to the value of the services that it provides – Mr Gershenhorn said that for lightweight packages, UPS expanded volumetric charges for ground shipments.
“At the same time, we have continued to see an increase of very large packages,” he said, and since these shipments require special handling and minimise the opportunities for automated processing, UPS increased the surcharge for these packages.
The analysts’ call became really interesting when Mr Gershenhorn revealed how e-commerce was faring: “We are in fact seeing strong growth in the Next Day Air and deferred products, driven largely by e-commerce, and specifically in that area we believe we are gaining market share.
“So we are pretty confident with the projections for e-commerce sales in the market and our customers are telling us that we are going to be seeing that 10% volume growth between Thanksgiving and New Year’s Eve.”
It is investing in new technologies to improve both service and efficiency.
“You are well aware of some of the things we are doing on the e-commerce side with UPS My Choice, UPS Access Point, UPS SurePost, UPS SurePost Redirect, our synchronised delivery service, i-parcel, and so on,” Mr Gershenhorn said.
When UPS chief financial officer Richard Peretz was questioned about EPS growth “from mid-single digits to the low-teens” in the fourth quarter – based on the top-end of the company’s guidance – he said “B2C looks like it’s going to have a solid quarter”, while “e-commerce is still expected to be strong”.
He added: “And we still feel that peak season will be strong because of the growth of e-commerce, and that’s reflected in the guidance, and the guidance does have the total company actually growing double-digit growth in profits for the fourth quarter as well.”
Finally, Mr Abney noted that the relationship between the third and fourth quarters had “migrated a little bit, just over this B2C growth”, and that prior to this big growth in B2C e-commerce the group’s “average peak day was increasing volume somewhere around 50% over a typical day”.
He said: “Now with e-commerce, last year we approached 75% over. So the nature of the business has changed.”
My final take
There’s no company better than Amazon able to capture the opportunity these market dynamics offer. Amazon is not splashing out top dollar on buybacks, and its share count is about half UPS’s 900 million.
It hasn’t been particularly good at generating EPS over 20 years, but it’s particularly good at stealing market share from incumbents, and UPS will have to develop a strategy to defend its position.
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