This Delivery Company Is No Good

Ron is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

United Parcel Service (NYSE: UPS) said Monday it will abandon a 5.2 billion Euro ($7 billion) bid for smaller Dutch parcel-delivery company TNT Express NV (NASDAQOTH: TNTEY) after encountering unexpectedly stiff objections to the deal from the European Commission.

The acquisition would have been the biggest in UPS's 105-year history. The European Commission, the EU's executive arm, is due to announce its decision on Feb. 5. UPS pre-empted the decision, saying after a meeting with the regulator on Friday that it expects Brussels to block the deal. Needless to say, with the news, the stock price of TNT Express has tanked by over 40% in just a day.

UPS wanted to buy the smaller firm to challenge Europe's largest, Deutsche Post's DHL (NASDAQOTH: DPSTF) on the European grounds, not to mention the assets in fast-growing Asia and Latin America. The collapse of the deal means a strategy rethink at UPS, and as Kurt Hoefer, research analyst at portfolio manager Golub Group in San Mateo, California, says, the company does not have "any alternative but to grow it organically," which means another string of smaller acquisitions coming up soon. But the impact is far greater on TNT. Although TNT is supposed to get 200 million Euros as termination fee, it is already struggling in a weak European market and lacks a strategy for developing on its own after nearly a year of negotiations on the merger. Yet this is what TNT said:

"In a statement, TNT conceded that the 'protracted merger process has been a distraction for management' and that it would now focus on reassuring customers, encouraging employees and making money."

With FedEx (NYSE: FDX) not showing sufficient interest in TNT, the unanimous opinion among financial experts is aptly put below.

"Now TNT will have to continue alone," said Philip Scholte, an analyst at Rabobank. "TNT's management will have to roll up their sleeves, come up with a plan and get down to work."

But before we talk about any acquisition, let's look at the financial disposition of UPS and whether both the stock price and the company are in the position of further growth of value or not.

Fundamental Analysis

Avondale Partners recently upgraded UPS to a buy rating. Not only Avondale, but several other analysts are showering favorable (or at least, neutral) ratings on UPS. 10 equity research analysts have rated the stock with a buy rating, three have issued an overweight rating, thirteen have assigned a hold rating, and one has assigned a sell rating to the stock. The stock presently has a consensus rating of overweight and a consensus target price of $85.32. The stock is currently trading at $79.33. The book value of each share is 7.90, which means the price-to-book ratio is 10.05, far higher than Fedex's 2.12 and TNT's 0.94. Even when the Street analysts are calling it a "buy" stock, this high price-to-book ratio is what makes me apprehensive about how far it can go up.

To know the truth, we must delve deeper into the financial statements. Take a look at the graph below.

<img src="" />

It is clear that the company has not reached its pre-Recession profitability yet. Although the revenue at $53.11 billion is the highest since 2003, net income margins linger at 7.16%, much lower than 9.11% in 2004. What is restraining the growth of the bottom line of the company?

(Numbers in billions)

<img align="middle" src="" />

Even the capital expenditure ratio has been steadily going down in recent years. Is the company not able to utilize its capital properly? On a second look at the FactSet data, there have been certain unusual expenses (not categorized under interest or taxes) of $424 million in FY11. And this has been continuing for four straight years since 2007. What is this expense for? It must be noted that when looking at the company statements, I don't see anything like that.

Declining long-term investments, decreasing long-term liabilities and surging cash assets - all these mean that UPS does not know what to invest in right now. Being rejected at this TNT deal, the company comes back to square one. How will the company increase its profitability? How would the cash be invested to gain better returns in the future? Huge question mark!

<img src="" />

If you look at the graph below, you will see that the stockholder's equity has continuously gone down since 2007 to its current $7.11 billion, yet the net income increased with the increase in sales. Now, that definitely results in a high return on equity (ROE) of 54.07%, compared to 13.55% of FedEx. That certainly seems to be inspiring at first look, but when we consider the regular share buybacks, it explains the high ROE.

<img src="" />

Another disturbing fact is the asset acquiring trend in the company. Check the graph below and you will understand that the company has been more focused on acquiring current assets (which includes cash, by the way) in the recent years. To add to that, goodwill has been written down in FY11 statements.

Yes, I see a drop in the long-term liabilities, which means that the company might be less liable to external creditors in the coming few years. This is good when the company's TTM levered FCF is $3.45 billion, almost half of total operating cash flow of $6.81 billion. This metric and the high total debt/equity ratio of 197.9 remind us that the company needs to shed liabilities that might be eating into the shareholder's equity as well. But without any solid long-term assets acquisition, the operating margin of 9.77% and net income margin of 6.11% might not improve over time.

<img align="middle" src="" />


To sum it all up, if you are a short-term investor, this company is a "Buy" at the moment. With the price uptrend and positivity from the deal termination, the stock price is supposed to go up for some time (at least until the next financial report is released).

For long-term value investors, the company does not seem to have strong fundamentals, and thus, it does not seem so alluring to me at the moment. Notwithstanding, the fact that with a dividend yield of 2.77% (which is still lower than 4.36% in 2008), compared to the 0.57% of FedEx, the stock might be a good source of dividend income.

RonChat has no position in any stocks mentioned. The Motley Fool recommends FedEx and United Parcel Service. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

blog comments powered by Disqus