Safe Income tier holding UPS (UPS) opened 5.5% lower this morning after earnings missed expectations and the company issued disappointing 2017 guidance. Fourth-quarter adjusted EPS of $1.63 missed analysts’ consensus estimate by six cents. Revenue rose 5.5% year-over-year, but missed estimates by $80 million. And for the full year, adjusted EPS of $5.75 fell well short of analysts’ $5.82 target.
The primary reason for the miss was a significant shift toward lower-margin products in the fourth quarter. Industrial production remains low, generating soft demand for supply chain and freight services and contributing to a decline in B2B delivery volume. At the same time, lower-margin B2C deliveries are growing quickly, as consumers shift more and more spending online.
In other words, UPS is delivering fewer truckloads of manufactured goods to warehouses and businesses, while delivering a lot more Amazon packages to people’s houses ... and unfortunately they’re not paid as well for the latter.
UPS management seemed surprised by the speed of this shift. However, they are responding. On the revenue side, they’re increasing prices for some low-margin products, especially oversize shipments. And on the cost side, they’re investing heavily in technology that will improve efficiency and lower their cost per package. In particular, the company is accelerating plans to automate its distribution hubs, to lower the cost of delivering packages to consumers.
However, these investments will increase UPS’ CapEx spending by 20% this year and next, cutting into EPS. In addition, UPS is facing currency headwinds that management expects to reduce EPS by 30 cents per share in 2017. All together, these headwinds led management to issue 2017 EPS guidance of $5.80-$6.10, representing year-over-year growth of only 1% to 6%.
Not everything is bleak: the industrial production outlook for 2017 has recently improved from negative to slightly positive, so B2B products could start growing again soon. And UPS would be a major beneficiary of corporate tax reform; the company currently has a tax rate of about 35%.
However, the lowered guidance and pressure on margins are likely to constrain the stock for some time. We’ll give the stock a day or two to find its footing—today is likely to be characterized by panic selling—but we’ll probably be cutting UPS loose soon. For now, UPS is a Hold.