United Postal Service and the Value in Delivery

One of Warren Buffett’s most followed rules for value investment is to buy stocks representing products or companies you use every day. The idea being that mass volume consumer products companies generate a lot of money and float.

A company that a lot of people use every day is UPS or United Parcel Service (NYSE: UPS) judging by the number of their trucks I see on the road. I live in a real small town, (population around 600) yet every time I walk across it on a weekday I see one or two UPS trucks driving around.

I also use UPS almost every week in shipping and in the stuff I order online. I recently ordered some Tide and aspirin through Walmart.com, it was shipped to me via UPS. The brown UPS van is also a regular visitor to my local post office.

UPS’s Parcel Volume is Exploding

Guess what I’m not alone the UPS Fact Sheet states the company moved 4.7 billion packages and documents in 2015. That number grew to 4.858 billion in 2016. That volume included18.3 million packages and documents each day and 2.6 million packages and documents shipped by air in the US each day alone.

The amount shipped by UPS is increasing all the time, parcel volume increased by 7.1% in fourth quarter 2016 and 4.6% for all of 2016, Internet Retailer reported. UPS delivered 1.433 billion packages during fourth quarter 2016 up from 1.338 billion during the same period in 2015.

During the 2016 holiday season UPS delivered 712 million packages around the globe. That was a 16% increase over holiday season 2015. Around 63% of those deliveries were to residential customers.

Thanks to ecommerce UPS’s business is growing by leaps and bounds and there seems to be no end in sight. Nearly half of US households had an Amazon Prime membership which entitles them to free two day shipping, CNN Money reported. That membership is growing fast, the number of Amazon Prime Memberships in the US increased by 35% during 2014 rising to 54 million.

Is UPS Making Money?

The future looks bright for UPS but cynical value investors will ask does it make money. To answer that question we’ll take a look at UPS’s financial numbers for fourth quarter 2016.

The numbers indicate that fourth quarter was pretty rocky for UPS, some of the highlights include:

• Revenues grew by $880 million rising from $60.03 billion in September to $60.91 billion in December. Overall UPS’s revenues grew by $2.55 billion in 2016, rising from $58.36 billion to $60.91 billion. That alone demonstrates that ecommerce is good for delivery.

• Net income fell but remained strong. UPS’s net income fell by $1.57 billion during third quarter, dropping from $5.001 billion in September to $3.431 billion in December this might indicate that the growth is not sustainable because costs are eating up revenue gains.

 

• The company reported a negative free cash flow of -$204 million in December 2016. That’s down from $284 million in December 2015, which looks disturbingly like a loss.

 

• UPS reported a negative profit margin of -1.41% on December 31, 2016.

• Disturbingly UPS reported making no cash from operations during fourth quarter 2016.

 

• Cash and short term investments remained strong at $4.567 billion on December 31, 2016. That indicates UPS still has a lot of float despite the negative free cash flow.

 

So UPS is making money but its looks as if its operations are not paying for them. That indicates the company’s business model and the revenue growth might not be sustainable.

One reason for this might be that UPS has had to use all of its excess cash to cover the cost of all those additional packages. That might mean that holiday season is becoming a money losing proposition for UPS.

The telling number at UPS will be if all the additional package volume generated by services like Amazon Prime starts paying for itself. If it does not UPS might be forced to rethink its business model. Unfortunately it might take several quarters or even years for this to happen.

A major dilemma for United Parcel Service is that it has to pay for a lot of new infrastructure to move the additional packages. Then spend several years paying for that infrastructure.

Is UPS a Good Investment?

Despite all this UPS is still paying off handsomely for investors. Shareholders received a 160% return on equity on December 31, 2016.

They also took home a 78¢ dividend on November 9, 2016, that was up from 73¢ a year later. More important that dividend is scheduled to grow to 83¢ on March 8, 2017, our friends at Seeking Alpha reported. That’s a 5¢ year increase for the past two years which sounds really good to me.

So UPS is still a good investment, but its long term prospects look somewhat dim. In addition to the falling income and profit margin there are some long term threats on the horizon.

The Greatest Threat to UPS

The greatest of these threats is the growing trend of retailers handling their own delivery. Both Amazon (NASDAQ: AMZN) and Walmart (NYSE: WMT) have been experimenting with same day delivery. Walmart has even tested a service that uses Uber and Lyft drivers to make online deliveries from a local store.

An even greater menace is “click and pull;” the pickup of online orders at brick and mortar stores. Walmart is leader in this sphere it offers free pickup for online orders and has opened a number of dedicated pick up locations, including branded Walmart Pick Up convenience stores.

Amazon has also been making noises about offering some sort of pick up. It is testing a brick and mortar grocery concept in Seattle. There is also the possibility of pickup lockers in retailers such as Walgreens and 7-Eleven.

Even developments such as Amazon’s air force threaten UPS because it might enable the use of couriers, Uber drivers or smaller delivery services for local delivery. That might be a real threat to UPS’s business.

Watch UPS closely folks because it might no longer be the safe value investment we assumed. Even with growing business this company has some real struggles ahead of it – that might make that 83¢ dividend a thing of the past.