UPS 10-Q Summary: Quarter Ended September 30, 2016
Business context and reporting period
United Parcel Service, Inc. reported results for the third quarter and nine months ended September 30, 2016, compared with the same 2015 periods. Its three reporting segments are U.S. Domestic Package, International Package, and Supply Chain & Freight.
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Revenue | $14.928 billion | $14.237 billion | $43.975 billion | $42.309 billion |
| Operating profit | $2.034 billion | $1.984 billion | $5.895 billion | $5.617 billion |
| Operating margin | 13.6% | 13.9% | 13.4% | 13.3% |
| Net income | $1.270 billion | $1.257 billion | $3.670 billion | $3.513 billion |
| Diluted EPS | $1.44 | $1.39 | $4.13 | $3.87 |
- Q3 revenue rose 4.9% and net income rose 1.0%; diluted EPS increased 3.6%. For the nine-month period, revenue increased 3.9%, net income 4.5%, and diluted EPS 6.7%.
- Average daily package volume increased 5.9% in Q3 and 3.6% year to date. Consolidated revenue per piece was nearly flat in Q3 at $10.49, and down 0.7% year to date at $10.48.
- Segment Q3 revenue and operating profit: U.S. Domestic Package $9.289 billion and $1.252 billion; International Package $3.024 billion and $576 million; Supply Chain & Freight $2.615 billion and $206 million.
- International operating profit increased 13.6% in Q3, with margin rising to 19.0%. U.S. Domestic operating profit was nearly flat and margin fell to 13.5%. Supply Chain & Freight operating profit declined 5.9%, and margin fell to 7.9%.
- Nine-month operating cash flow was $5.363 billion, down from $6.415 billion. The filing attributes the decrease mainly to higher pension and postretirement contributions and reduced hedge-margin collateral receipts.
- Nine-month investing cash outflow was $2.027 billion, including $1.837 billion of capital expenditures. Financing cash outflow was $2.781 billion, including $2.007 billion of share repurchases and $1.987 billion of dividends.
- At September 30, cash and cash equivalents were $3.299 billion and marketable securities were $2.059 billion. Current assets were $12.853 billion versus current liabilities of $10.889 billion.
- Total debt was $15.326 billion, including $3.820 billion in current maturities and commercial paper; long-term debt was $11.506 billion. Debt was up from $14.334 billion at year-end 2015. The reported debt-to-total-capitalization ratio was 84.7%.
Material changes and management commentary
- Domestic package growth was driven by e-commerce and business-to-consumer shipments. Higher wages, benefits, healthcare and workers’ compensation costs weighed on domestic margins; productivity and technology initiatives partly offset cost pressure.
- International results benefited from volume growth, revenue management, network changes and cost containment, while lower fuel surcharges, currency effects and lower revenue per piece constrained revenue.
- Supply Chain & Freight revenue growth was substantially affected by the 2015 Coyote acquisition. Freight volumes and tonnage declined, while forwarding faced soft market conditions and lower yields.
- Management described economic conditions as mixed: modest U.S. growth but weak industrial production and business investment, uneven international growth, volatile currencies and uncertainty related to the United Kingdom’s planned EU exit. UPS cited network flexibility, automation and its ORION routing system as efficiency and capacity initiatives.
Outlook, risks and unusual items
- The filing does not provide a clear full-year earnings or revenue forecast. UPS expected 2016 capital expenditures of approximately $2.8 billion and share repurchases of approximately $2.7 billion.
- UPS announced average net rate increases of 4.9% for Ground, Air and International services effective December 26, 2016. UPS Freight rates had increased an average net 4.9% effective September 19, 2016.
- UPS disclosed a potential pension exposure tied to the Central States Pension Fund (CSPF). If the CSPF becomes insolvent and benefits are reduced, UPS’s coordinating benefit obligation could increase the UPS/IBT Plan’s projected benefit obligation by approximately $4 billion. No additional liability was recorded because timing and amount remain uncertain. The CSPF had projected insolvency in 2025; Treasury rejected its proposed benefit-reduction plan in May 2016.
- Other disclosed legal matters include the New York State and City cigarette-delivery case, a pending DOJ investigation and appeal relating to third-party shipper negotiators, and franchisee and Canadian proceedings. UPS said it could not estimate possible losses for several matters.
- Purchase commitments, including an October 2016 order for 14 Boeing 747-8 freighters and an option for 14 more, total expected outflows of $466 million for the remainder of 2016, $1.020 billion in 2017 and $1.010 billion in 2018, with further commitments thereafter.
- Key operating risks include labor negotiations, employee benefit and pension costs, fuel prices, currency and interest-rate changes, competition, economic conditions, cybersecurity and technology disruptions, and litigation. The IPA pilot agreement was ratified and took effect September 1, 2016; negotiations with airline mechanics remained ongoing.
Most important facts for investors to verify
- Whether package volume growth can translate into stronger yields and margins amid higher labor and benefit costs.
- The sustainability of international margin gains and the scale of continuing pressure in Freight and forwarding.
- Cash generation after pension contributions, capital spending, dividends and repurchases; and the planned financing of debt maturities and commitments.
- Developments in the CSPF and any resulting change to UPS’s potential pension obligation.
- Outcomes of significant legal proceedings and any updates to loss estimates, if estimable.
- Execution and returns from the 747-8 order, facility automation and other capacity investments.