Morningstar | UPS Updated Forecasts and Estimates from 09 Nov 2018
UPS' third-quarter growth was solid, and the firm has begun its transformation plan. UPS grew its third-quarter top line 8% and expanded revenue in all three segments while improving revenue per piece by 4.0%; reported and normalized EPS grew at an impressive 20% and 26% year over year. Management bumped up full-year free cash flow guidance from $4.5 billion-$5 billion to “more than $5 billion.†We maintain our wide moat rating and plan to maintain our fair value estimate at this time. However, we note margins deteriorated by at least 100 basis points in both of the largest segments, and while some of this is due to transformation spending, need for margin preservation is evident.We were most impressed by the nearly 4% improvement in base rates in the firm’s largest segment, domestic U.S. By comparison, in the first and second quarters this metric improved 2.5% and 3.3% year over year. Domestic grew revenue 8% but operating margin was compressed by pension and expansion project expense, by about 100 basis points on an adjusted basis, to 9.5%. The international segment produced 3% top-line growth (5% on a currency neutral basis) and normalized margin here too compressed, by about 140 basis points to 16.6% due to fuel and currency. Supply chain and freight grew sales a strong 12% including 11% growth within the LTL freight segment--not a huge surprise given current demand and high rates due to capacity constraints in U.S. trucking. Supply chain and freight operating profit improved about 120 basis points to 7.4%, but this is the smallest segment.
Margin concern is the impetus for the transformation, and we note a few developments. UPS launched its Ware2Go platform to increase demand for two-day deliveries from strategically located warehouses around the country. The firm expanded MyChoice from 16 to 112 countries and will launch a business version next year. UPS this year completed 22 new or retrofit automated sites including the just-opened Atlanta super hub.
These are about to get a test. In the coming peak season, UPS expects to deliver 800 million packages and hire 100 thousand seasonal employees, up from 750 million and 95 thousand last year. The firm added six 747-9 and three 767-300s to expand international capacity, and this frees aircraft to join the U.S. fleet.
Margin compression is a concern when mix is diluted with cheap, single residential packages and the firm is spending to grow capacity. The three legs of UPS' transformation strategy are: 1. Generating higher-quality revenue (customers in small and medium businesses, health care, high growth economies, and B2B e-commerce); 2. Using technology to increase efficiency of network operations and support staff; and 3. Developing a culture of continuous transformation to hasten new ideas into processes. These initiatives make sense to us, and we believe sorting facility automation at any sites of size will bear fruit quickly.
United Parcel Service provides transportation services, primarily domestic and international letter and package delivery. The company reports its operations in three segments: United States Domestic Package, which includes the time-definite delivery of letters, documents and packages throughout the United States; International Package, which includes delivery to several countries and territories worldwide, including shipments wholly outside the United States, as well as shipments with either origin or destination outside the United States; and Supply Chain & Freight, which includes the company's Forwarding, Logistics, Coyote, Marken, UPS Mail Innovations, UPS Freight and other aggregated business units.
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