E-commerce Drives UPS’s Revenue But Negatively Impacts Yields And Forecast

United Parcel Service (NYSE:UPS) announced its second quarter 2014 results on July 29 2014, posting 5.6% year-on-year growth in revenue driven by booming e-commerce sales. ^[1] However, growing e-commerce packages also ate into the company’s yields (revenue per unit). In anticipation of high volume of e-commerce packages during the upcoming holiday season, the company has decided to invest in its network in order to not repeat the fiasco witnessed during Christmas 2013.

UPS’ net profits declined 57.6%, to reach $454 million, due to recognition of a charge related to the transferring of post retirement liabilities of certain employees to defined contribution plans. ^[1] Excluding this impact, UPS’ net profits increased 4.5% driving 7% growth in earnings per share, which reached $1.2. Following the announcement of the second quarter results, UPS’ stock declined 3.6% since investors did not appreciate the lowered earnings per share guidance.

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High e-commerce package volume drives UPS’s U.S. Domestic Package segment

The e-commerce industry in the U.S has been booming. In 2013, e-commerce sales grew 17%, increasing its contribution to overall retail sales from 5.2% to 5.8%. ^[2] This is because, not only is online shopping more convenient, but has also become more accessible due to the increase in smartphones and tablets and higher internet penetration. Many brick-and-mortar retailers have rolled out online shopping portals to cater to the growing online retail shopping customer base. Deals and discounts on online shopping also encourage customers to purchase via websites rather than traditional stores. UPS’ package volume is directly impacted by e-commerce sales since many online retailers, such as Amazon (NASDAQ:AMZN), employ UPS’ services in order to offer their customers timely and economical delivery of products.

In the second quarter, UPS’ average daily Ground package volume increased 8.1% on account of high e-commerce packages. ^[1] We expect to see continued growth in UPS’ U.S. Domestic Package segment driven by the projected 12% growth in e-commerce sales in 2014. ^[3]

Yield declines due to unfavorable package mix

E-commerce players prefer to avail low-cost delivery services in order to keep their shipping costs to a minimum. They use these low delivery charges as an incentive to attract customers. The increase in demand for low-cost delivery services by e-commerce helped drive UPS SurePost volumes by 60% during the second quarter. ^[4]

Though e-commerce packages have helped boost UPS’ U.S. Domestic Package volumes, they have negatively impacted yields. The increase in UPS SurePost volumes, which is a low yield service, led to an unfavorable product mix which resulted in a 2.0% decline in average yield for UPS’ U.S. Domestic Package segment. ^[1]

The move to low-cost delivery services is also evident across world. UPS’s International Package segment’s average yield declined 1.7% on a currency-neutral basis due to the high volume of packages employing non-premium services.

The decline in yields is expected to continue through 2014. Post December 28 2014, UPS will use dimensional weight to calculate the billable price of all Ground packages in the U.S. and Standard packages to Canada. ^[5] With dimensional weight based pricing, UPS should be able to improve its yields through better price realizations. Its margins should also increase since rates would be more aligned with costs (For more information about how dimensional weight based pricing improves margins please refer to our article here).

Preparations for holiday season volume will increase operating expense and bring down earnings

Similar to last year, UPS expects to see high package volume driven by e-commerce sales during the holiday season. However, it wants to avoid the delay in package delivery seen last year, which was caused by the overwhelming package volumes and harsh weather conditions. UPS has therefore decided to take up certain measures that will set it back by $175 million. Due to the high operating expense forecast, the company’s management lowered its earnings per share guidance from $5.05-$5.30 to $4.9-$5.0, representing a 7-9% increase over 2013. ^[4]

In anticipation of the high package volume during this year’s holiday season, UPS has decided to add 50 new sorting facilities in existing hubs that will help increase its capacity by 5%. ^[6] Traditionally, operations have been limited on Black Friday, however this year the company will operate for the full day. This should add to the operating costs. UPS has also accelerated the rollout of its route optimization software, ORION, which will help reduce delivery times and costs during the peak season. It expects to have around 45% of its drivers using ORION by the holiday season.

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1. UPS Q2 2014 Financials, www.ups.com [↩] [↩] [↩] [↩]
2. U.S. Census Bureau Quarterly E-commerce Report, www.census.gov [↩]
3. Global B2C Ecommerce Sales to Hit $1.5 Trillion This Year Driven by Growth in Emerging Markets, February 3 2014, www.emarketer.com [↩]
4. UPS Q2 2014 News Release, July 29 2014, www.ups.com [↩] [↩]
5. UPS Announces Dimensional Weight Changes, June 17 2014, www.ups.com [↩]
6. United Parcel Service’s (UPS) CEO Scott Davis on Q2 2014 Results – Earnings Call Transcript, July 29 2014, www.seekingalpha.com [↩]