United Parcel Service Inc. (UPS, Financial) recently revealed a weak outlook for FY2015, most likely the result of an expected sharp drop in fourth quarter earnings following extra expenditure incurred during the holiday season. Although the company had been working towards fixing problems related to the handling of last-minute online orders, the holiday rush cost UPS at least $200 million more than anticipated. While UPS’s operating expenditure grew from $13 billion in the prior-year quarter to $15.1 billion in Q4 2014, profits for the December quarter plunged from $1.17 billion a year earlier to just $453 million, translating into a 76 cents loss in earnings per share.
Profits take a hit owing to high ‘holiday season’ operating costs
UPS’s fourth-quarter revenue grew from $14.9 billion in the prior-year quarter to $15.9 billion, in line with expert estimates. While the company witnessed a 75% climb in revenue by $10 billion in the domestic market, revenue from the international market, excluding foreign exchange effects, increased 5.9% by $3.4 billion. However, high operating expenses resulted in a very small portion of the revenue trickling down to the bottom line.
After the debacle in the 2013 holiday season deliveries, UPS has been making some significant changes in its delivery mechanism. The company hired 100,000 seasonal employees, added sorting facilities, stepped-up on the implementation of ORION, its route optimization software that helps reduce delivery costs and times, and invested in developing around 30 novel technology solutions.
While the expanded infrastructure helped UPS deliver around 1.3 billion packages in the fourth quarter, an 8.1% increase compared to the same period last year, it also took the toll on UPS’s operating expenditure for 2014, dragging down the company’s earnings. UPS generated free cash flow of $3.4 billion in FY2014, against a capital expenditure of $2.3 billion, logging in GAAP-diluted earnings per share of just $0.49 for Q4 2014 compared to the previous year’s $1.25. Further, the company’s fourth-quarter operating profits from the domestic and international markets were down 63% and 38% to $444 million and $335 million, respectively, on a reported basis, owing to the transfer of certain healthcare liabilities and the pension mark-to-market charge.
On a positive note, UPS’s revenues from its Supply Chain and Freight segment increased 7.4% to $2.5 billion on the back of growth in the company’s distribution and freight units, leading to an adjusted operating profit of $179 million in the segment.
Outlook for 2015
UPS projected per-share earnings in the $5.05-$5.30 range for FY2015, up 6% to 12% over adjusted results for FY2014. While the company is expecting its per-share earnings in the new fiscal to be below the company's long-term growth target of 9%-13%, experts predict the figures to lie in the range of $5.05-$6.00 per share.
UPS plans to reach its FY2015 goals by raising prices and controlling expenditure. The company announced plans to implement a 2% to 3% across the board price hike, with surcharges to be levied on most domestic packages, in an attempt to balance the disparity between cost and revenue actions. The company, which witnessed 8.1% growth in global shipments in Q4 2014 compared to the prior year, contributing to a 6.1% rise in revenue to $15.9 billion, also expects to benefit from the trend of increasing online orders that need to be shipped to their destinations as against in-shop purchases.
Although experts predict a sluggish but steady growth for the company in the upcoming years, UPS faces considerable near-term threats from factors such as labor unionization, economic upheaval and increased competition from rivals like Radiant Logistics Inc. (RLGT, Financial) and FedEx Corp. (FDX, Financial).
Final thoughts
A number of factors are currently playing in favor of UPS as an investing option. The company’s shares are currently trading at nearly 31 times its earnings. While UPS boasts a higher PE ratio than rival FedEx, indicating investor confidence in the company’s future growth prospects, the company has a strong tradition in terms of dividend payout. In 2014 alone, UPS bought back over 26 million shares for around $2.7 billion and spent $2.4 billion in dividend payments to its shareholders. The company’s efforts to reward investors through share buybacks and dividend payments have gone down well with experts and investors alike.
While a booming health care segment, productivity improvements as well as a growth in shipment and yield are expected to lend to UPS’s steady growth in the coming years, the company’s enhanced global network, technology-backed operations and strategic investments are expected to reinforce its market position and safeguard shareholder value against unfavorable market dynamics.
