UPS Deliveries To Investors Include Strong Earnings Quality
Online retailing has been a boon not only for companies like Amazon (AMZN.O) and for customers addicted to near-instant gratification, but also for the shipping companies who form the link between those retailers and their customers, such as United Parcel Service (UPS.N). Delivering online orders has proved to be a robust business, meaning that UPS has done better than might have been expected, even in the midst of a weak global economy. Now the company is getting another assist in the shape of crude oil prices, which began a rapid slide some six weeks ago. (See the chart below for details.) UPS continues to levy a fuel surcharge on its customers, and the lower fuel prices, combined with the decline in fuel prices gives a boost to the company’s bottom line. That slide in the price of oil and related energy products is just the icing on the cake, however; even without the added benefit of such short-term gains, the company already had a very high StarMine Earnings Quality (EQ) score of 91, based on the longer-term sustainability of its earnings and not just on the potentially short-lived extra gain from commodity price changes. Rather, it is the strength of UPS’s core business that enables the company to post such a high score, and causes us to include it as the latest in our series of articles devoted to companies with particularly high or low StarMine EQ scores.
To generate its proprietary Earnings Quality (EQ) scores, StarMine uses computer-driven models to analyze the financial statements of more than 33,000 companies and to calculate a ranking for each. These scores have proven to be reliable predictors of the extent to which a company generates earnings that are sustainable over the coming quarters. Expressed on a scale of 1 to 100, with a higher score indicating higher-quality earnings, the StarMine EQ model enables investors to compare a company’s earnings quality against that of its peers, companies in the same region or across the entire universe of stocks. Companies with low StarMine EQ scores are likely to have difficulty in sustaining past earnings, while a high StarMine EQ score is a sign that a company is generating its profits from solid business fundamentals.
Strong cash flows are a good indicator that a company’s earnings are sustainable. The chart below shows UPS’s cash flow from operations (CFFO) and its net income for UPS, with the green section of each bar indicating the amount by which cash flow exceeds net income for the quarter. (A red section indicates a period during which CFFO lagged net income.) As you can see, UPS consistently generates CFFO at levels higher than its net income. Furthermore, the company reported that its CFFO last quarter (ended March 31, 2012) was $2.3 billion, the highest since early 2008 and significantly above than its net income, which reached $1 billion. UPS’s free cash flow (FCF) paints a similar picture: FCF of $1.8 billion in the latest quarter far exceeded the company’s net income in the same period. FCF represents the amount of cash that is potentially available to investors after all capital spending and other capital expenses are accounted for. Earnings backed by strong cash flows tend to be more sustainable than non-cash earnings.
The level of return on net operating assets measures a company’s operating efficiency, and is another indicator of earnings sustainability. Our research has found that the higher returns of this kind a company can generate, the greater the probability that it will be able to sustain its earnings in the future. At the height of the global financial crisis – for much of 2008 and 2009 – the weak global economy dragged the company’s return on net operating assets (represented by the blue line) lower. However, over the past three years, UPS has been able to reverse that trend and seen its return on net operating assets rise fairly steadily to hit 43% in the most recent quarter, a level significantly above the industry median of 25% (represented by the gold line in the chart below). That is the highest level of return on net operating assets that UPS has achieved in the last five years, and it is one reason that the company’s return on equity (ROE) is an impressive 13%, far above the industry median of 3%.
UPS still generates more than 60% of its revenues from shipments within the United States. However, the company is seeing gains in its international deliveries, and the recent acquisition of TNT Express will further boost that international footprint. Its supply chain and freight logistics business division will help the company continue to do well even if the global economy continues to weaken. UPS – popularly referred to as “Brown”, in a nod to the color of its iconic delivery trucks and the uniforms of its drivers — recently placed an order for a small fleet eco-friendly delivery trucks: is “Brown” going green? While that might reduce its exposure to volatile gasoline prices over the long haul, at this stage it’s merely interesting news. It is the core operations of UPS and its ability to continue to keep returns on net operating assets and cash flow from operations at high levels that help to explain its high StarMine EQ model score, signaling that its high-quality earnings are likely to be sustainable.
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