What’s Up with UPS?

In addition to have a strong balance sheet, UPS clearly delivered a solid Q4’15.  Revenue grew 2.6% year to year.  Earnings increased by 5% sequentially and y/y by 9% y/y, exceeding street estimates for the fourth straight quarter.  The volume has increased by 2.4%, equivalent to a 2% increase in yields (revenue/package), and margins expanded by 186 bps across various segments.

The main drivers for the positivity include better base pricing, strong e-commerce demand, gains from falling oil prices, and mostly importantly, the synergetic operational efficiency from Coyote acquisition.  The results were also accompanied by upbeat 2016 guidance, steadily increasing dividend yield at 3%, and $15 billion of stock repurchases by 2019.

No success comes without its own ironies.  As fuel cost is the most important dimension for the Transportation Industry, the company adds on fuel surcharges to hedge volatile energy prices.  While UPS’ fuel cost, $2.5 billion in 2015, has fallen from 7.3% to 5.8% since 2013’s oil prices’ slides, the surcharge has reduced, too, to less than 10% for domestic air and 7% for ground products.

While the oil price drop cuts in surcharge revenue, it has been more than offset by the operational efficiency through the acquisition of Coyote Logistics in 2015.  Coyote is expected to bring in $100 million worth of synergies to help UPS to expand to its service platform.  Although global forwarding tonnage has been lower, demand/capacity imbalance, albeit under pressure, generates strong yield as international freight benefited from strengthening buy/sell spreads.

The surging e-commerce demand brings opportunities but also challenges.  A higher e-commerce driven top-line growth does not filter through to the bottom line automatically.  UPS has indeed demonstrating the ability of monetizing surging e-commerce volume.  The demand/capacity ratio is improving in the recent quarters.  However, at least during peak periods, e-commerce driven demand has not produced the same profit growth as it used to.

Critics may argue that Amazon’s recent move to build its own delivery networks could threaten UPS and FedEx.  Though, the general consensus is that it should not pose a serious threat to the well capitalized, superior technological advanced companies.

For the last 100 years, other than the largest global package delivery business, UPS has developed the Supply Chain & Freight Solutions segment which includes UPS Forwarding, Contract Logistics, and UPS Freight, to name a few major units, which serve over 175 countries.

Under the worst scenario, if UPS loses Amazon as their largest customer ($1 billion of $60 billion revenue), the impact on annual EPS would be minimal, $0.06 of $5.52.  By the way, UPS guided 2016’s CAPEX $2.8 billion, and mind you that, DHL has tried and failed to enter the U.S. domestic shipping market after $10 billion loss.

That being said, no one should trivialize the stiff competition from rival FedEx.  Case in point, UPS is appealing a decision by Brazilian regulators to approve FedEx’s takeover of Netherlands’ TNT Express.  FedEx has cleared the antitrust concerns with US, European, Brazilian, and soon Chinese authorities.  With the acquisition of Express, FedEx will have 22% of the European express delivery market, closing in fast to the UPS’s 25% share. TNT’s strength in Europe, partnered with FedEx’s clear market leader in the US In ground shipping, will undoubtedly present a major threat to UPS.

In the short run, as transportation leads industrials, UPS is inevitably sensitive to the signs of global economy slowdown and more importantly, contractions in B2B and B2C growth.

 

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