UPS Expects Strong Domestic Package Demand But Lower Yields Will Hurt Margins

by Trefis Team
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United Parcel Service (NYSE:UPS) will announce its second quarter earnings on July 23. Last week, the company revealed the expected earnings for the second quarter, which were short of expectations. UPS now estimates a net income of $1.13 per share instead of $1.20 that the market was anticipating. The company also reduced the full year earnings guidance to $4.65 to $4.85, from prior expectations of $4.80 to $5.06. [1]

Shares of the company fell 6% after the announcement. It has still been a good year for the company as its shares are up almost 20%. Overcapacity in the global freight industry combined with a customer predilection for lower-yielding shipping solutions is hurting the profitability of logistics and transportation companies. UPS is less affected than FedEx since it has traditionally not relied significantly on express air services.

U.S. Domestic Package Solid

Almost 60% of the valuation is attributable to the company’s domestic operations, which continue to remain solid. Going forward, we expect the division to continue to see volume growth driven by the e-commerce boom. In the domestic ground package, we expect volumes to grow by about 5% in 2013.

A customer shift towards premium offerings like UPS My Choice and UPS Returns will be the key to improving yields (or the revenue/package) and in turn, profitability. UPS recently expanded the My Choice product to its SurePost deliveries. UPS SurePost leverages U.S. Postal Service’s extensive ground delivery system to provide economic, non-urgent small package delivery services to residential addresses throughout the U.S.

Increased flexibility by allowing My Choice members to upgrade UPS SurePost package to UPS Ground for an additional fee not only creates product differentiation, but it also helps the company improve its profitability.

See Our Complete Analysis of UPS

International Geographies Offer Potential

UPS is also doing well to increase its presence internationally, not just by expanding into new geographies, but also by molding its delivery models to better suit the changing industry dynamics. For example, a few months back, it announced the expansion of its expedited ocean freight services to Western Europe. The move is part of the company’s strategy to expand its preferred less-than-container load (PLCL) freight service that was started in 2011, to provide shippers with an intermediate option between the fast air freight and the economic standard ocean freight.

The macroeconomic environment is still uncertain globally and companies are having to cut down on costs. Therefore, an intermediate offering like the PLCL makes a lot of sense.

In the emerging economies, China’s domestic delivery market holds a huge potential and could grow fivefold to $26 billion within the next 8-10 years. Foreign delivery companies have a limited presence in China. Until last year, foreign express delivery companies were barred from delivering within the country but things have eased off a bit since. Now, foreign companies have access to a limited number of cities within China. UPS, for example, is allowed to deliver in 19 cities across the country.

Besides focusing on traditional delivery services, the company is also looking to acquire Chinese delivery companies with a regional presence to enhance its presence in shipping related to healthcare products. Not only will the move give the company an opportunity to have a stronger foothold of the Chinese domestic delivery market, but medical transportation services offer fatter margins as well. Shipping medical devices and equipment often requires specialized handling and is the reason why shipping companies can charge a premium for such services.

We are positive on the long-term growth prospects of the international operations primarily due to growth in global trade fueled by rising incomes in emerging markets.

We have a $ 86 price estimate for UPS, which is in line with the current market price.

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Notes:
  1. UPS Announces 2nd Quarter Expected Results, investors.ups.com []
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