EUR 850.00 For Business Accounts Only

Morningstar | UPS Domestic Expansion Costs Outpace Revenue, but 4Q Shows Growing B2B Demand and Solid Pricing

UPS grew normalized fourth-quarter EPS nearly 17% to $1.94 versus $1.66 in the prior-year period and the $1.91 consensus expectation, and boosted its top line 4.6%. Importantly, UPS did not stumble with poor service or over-staffing during peak season. However, costs in its largest segment (domestic) expanded faster than revenue due in part to capacity expansion efforts, particularly opening 14 facilities during the period. Normalized domestic operating margin declined about a percentage point to 7.9%, improved slightly to 20.4% in international, and declined slightly to 6.5% in supply chain and freight. The latter we attribute to $60 million of lost profit when UPS LTL declined customer shipments for several days due to fulfillment uncertainty during union contract negotiations.

We believe investors already have tempered domestic margin in mind as these are heavy expansion and investment quarters for the parcel titan. We expect the market will focus on the positive outlook for 2019, when management expects impressive double-digit growth in normalized EBIT for all segments, excluding transformation costs. UPS opened 22 new or retrofit automated facilities in 2018 including five new super hubs, and 18 new or retrofit U.S. facilities projects are underway. We maintain our wide moat rating and expect any increase to our fair value estimate will be modest; we already model double-digit EPS growth this year.

Much of the revenue improvement was due to the 4.1% improvement in overall revenue yield, with gains in all products. Crediting simplified pricing for small and medium customers the firm also realized 3% fourth-quarter growth in B2B. Base rates in domestic improved a healthy 3.3% and grew average daily volume 3%. Also healthy: While transports typically have weak free cash flow conversion, in 2018 UPS boasted normalized net income at 100% of cash from operations less capital expenditures. However, 2019 free cash will reap no recurrence of a 2018 tax refund.

Based on FedEx’s December slight earnings guidance downgrade due to some top-line malaise in Europe, we were keen to hear UPS’ perspective. UPS indicated the firm does see the global headwinds identified by others but downplayed European decline, in our opinion. It is focused on opportunities, particularly in its supply chain business, as well as on tailwinds from e-commerce. During the period UPS Europe grew revenue in the high single digits and grew profit about 15%. Management considered it to be “a nice quarter” in Europe and sees similar in 2019.

In addition to the aforementioned double-digit EBIT growth management expects for all three segments in 2019, the firm also indicated capital expenditures will be 8.5%-10% of revenue, greater at the midpoint than our prior 8.5% projection. Adjusted 2019 EPS guidance of $7.45-$7.75 is about 6% below our prior projection, but new guidance includes $325 million of pension financing costs which we had not incorporated. We’ll true up our model but expect many of these factors to largely offset one another and we do not anticipate a material change to our valuation estimate.