Logistics companies have been some of the most adversely impacted by the U.S.-China trade dispute. Shares of UPS (UPS, Financial) are trading near five-year lows, with a forward price-earnings multiple of 13.5. Financial results have also been underwhelming -- the company recently missed revenue and earnings expectation for the first quarter of 2019. Is there any good news for shareholders?
Recent financials
UPS's revenue for the first quarter of 2019 was $17.16 billion, missing analyst expectations by $630 million and representing just a 0.3% increase year-on-year. Non-GAAP earnings per share came in at $1.39, missing consensus by 4 cents. GAAP earnings per share were $1.28. What was the reason for this underperformance?
According to management, this year’s severe weather during the winter months depressed earnings per share by 7 cents, more than the difference between expected and actual earnings. While there is no guarantee that next year won’t be as cold as this winter was, this is at least a problem that affects all logistics companies equally. Additionally, capital expenditures have really soaked up free cash flow over the last few years, and are expected to reach $7 billion this year.
Amazon on the horizon
We have discussed previously the risk that Amazon (AMZN, Financial) poses to both UPS and its main rival, FedEx (FDX, Financial). In a nutshell, Amazon has been developing its own network of warehouses and fleet of cargo planes, and has recently devoted more resources to expanding Amazon Air, its own freight delivery service. Amazon accounts for 50% of e-commerce sales in the U.S., which allows it to negotiate lower rates with UPS and FedEx, forcing the legacy logistics companies to charge other customers more to make up the difference. This in turn makes Amazon’s own delivery service more competitive relative to the established players.
Logistics is an incredibly capital-intensive business, and UPS is a truly enormous company -- it has 500 aircraft, over 120,000 vehicles and almost 500,000 employees. While Amazon is definitely attempting to take on UPS and FedEx, it remains to be seen whether they can scale their operations efficiently enough to compete on a significant level. And UPS isn’t sitting on its hands either -- the push to automate its distribution centres was clearly done at least in part as a response to this increased competition.
Summary
UPS sports a dividend yield of over 4%, significantly higher than the industry average of 2%. Now, whether that can be sustained with capex taking up so much free cash flow remains an open question. But the company has a solid history of dividend increases and aims for a payout ratio of at least 50%. This, combined with its historically low valuation, may make it of interest to some income investors.
Disclosure: The author owns no stocks mentioned.
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