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UPS (UPS) has been making some significant efforts to remain ahead of its competitors since it started the "Pain in the (Supply) Chain" healthcare survey in 2008 to analyze the growth prospects of its healthcare distributions solutions business. According to the survey, 59% of the 441 healthcare executive respondents will rely on third-party logistics partners since their biggest concern had been product protection during transit. Companies in the forwarding and logistics industry can expect significant revenue from providing healthcare distribution solutions to the healthcare device manufacturing companies.

Let's take a look at UPS's capital spending activities and what it expects from growth in the healthcare distribution solutions division.

Expecting to grow in the healthcare distribution system

In the first six months of the present fiscal year, UPS generated $2.693 billion in revenue from its forwarding and logistics business, a decrease of 7.4% year over year. This segment's revenue from freight decreased, and revenue from logistics increased over the period, riding on increased growth in healthcare distribution solutions. The global healthcare devices market is expected to grow 4.4% until 2018. We expect that healthcare device manufacturing companies will require sophisticated shipping facilities for their products, which may lead to continuous growth in the healthcare distribution solutions business for those with the proper facilities. UPS expects to harness this growth by expanding its healthcare distribution facilities.

In UPS' last annual report, its freight and logistics operations had around 28.6 million square feet of floor space; out of this, 6 million square feet had been dedicated towards healthcare distribution solutions. To grow its healthcare distribution solutions business, the company acquired Cemelog in July 2013. Cemelog is a medical logistics provider operating in Central and Eastern Europe. The acquisition will add 255,000 square feet to UPS' healthcare logistics facilities, and the overall healthcare distribution system space will increase by 4.25% to 6.0255 million square feet.

UPS will also be acquiring Union Pak de Costa, a Costa Rican company that is known to serve medical device manufacturers. The acquisition will complete by the fourth quarter of the present fiscal year, and its impact will be witnessed in the revenue from healthcare distribution companies in the forthcoming fiscal year ended May 2015.

In the current scenario, the healthcare distribution solutions business will grow by more than 4.25% to at least $1.30 billion in the coming fiscal year based on the growth in area allocated to healthcare distribution solutions and the impact of the acquisition of Union Pak de Costa. This growth is significant since UPS' overall revenue increased by just 1.1% year over year in the last quarter. Such positive results from the division give us an indication that it can improve the company's topline in the upcoming fiscal results.

Is the company making enough investments to beat its peers

FedEx (FDX), UPS' nearest rival, plans to spend $4 billion by the end of the present fiscal year to reinvestment in its areas of operation. Both FedEx and UPS are known for making constant capital expenditures, but in the last quarter, UPS made capital expenditures of just $537 million, while FedEx made capital expenditures of $945 million in its last quarter results. Despite lower capital expenditures, UPS' operating profit was $1.74 billion and FedEx's was just $517 million. According to our analysis, the reinvestment rate of FedEx stood at 523% in the last quarter, riding on its huge retained earnings of $18.51 billion. UPS has not been as aggressive as FedEx in reinvestments since its reinvestment rate stood at just 11.33%. Reinvestment rate can be defined as the percentage of cash flows that is reinvested in the business.

C.H. Robinson (CHRW), the third-largest company in the air delivery and freight services industry, generated operating profit of just $181.88 million but had a reinvestment rate of 18.23% in its last quarter results. So, it is quite evident that UPS should come up to par with its peers in terms of reinvestments.

A close look at UPS and its peers

Company

EV/Revenue

EV/EBITDA

TTM Return on Equity

UPS

1.63

28.19

14.60%

Fedex

0.72

5.72

9.72%

C.H. Robinson

0.79

12.4

42.34%

Source: Yahoo Finance

From the above table, we can easily infer that UPS is not looking as lucrative with respect to its revenue generation ability since its EV/Revenue stood highest among its peers. Along with this, its EV/EBITDA also stood highest, which raises questions regarding its profitability, but it's giving quite significant returns to shareholders. Its return on equity has been better than FedEx's return on equity by 5%, standing at 14.60%.

Conclusion

Although UPS has not been as aggressive as FedEx in terms of reinvestments in the present business, its topline may continue to grow with its plan to develop its healthcare distribution solutions business and to witness maximum share from the market.

Historically, there has been a positive correlation between the stock movements of both the companies. We recommend a buy as we expect that UPS can ensure steady capital returns in the future.

Source: UPS: Can Healthcare Deliveries Lead To Higher Returns?

Additional disclosure: Fusion Research is a team of equity analysts. This article was written by Shweta Dubey, one of our research analysts. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.