UPS Grows On E-Commerce; Highlights Holiday Season Preparations

United Parcel Service (NYSE:UPS) posted 5.7% growth in its third quarter revenue to reach $14.2 billion. ^[1] Revenue growth, though driven by growth in all segments, was primarily the result of increase in e-commerce volumes. However, the rising e-commerce shipments are continually pushing down revenue per package for UPS’s U.S. Domestic packages. UPS’s operating profit improved 8.3% year-on-year driven by productivity improvements, wage rate deflation and a reductions to workers’ compensation expense. The increase in operating profit helped fuel 10.7% growth in net profits and 13.8% increase in diluted earnings per share.

As you might recall, during last year’s holiday season, overwhelming package volume and bad weather caused severe disruptions in UPS’s service. This also had a negative impact on its earnings result for that quarter. This is why, during its third quarter earnings call, UPS was focused on making its investors and customers aware of its preparations to handle high package volumes during the holiday season driven by the growing e-commerce sales. However, because of the costs associated with these preparations, 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. ^[1]

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E-commerce boom drives UPS’ domestic volumes

In the third quarter, UPS’ average daily U.S. domestic package volume grew 6.2% and revenue increased 5.3% on account of high e-commerce packages. Retail e-commerce platforms are gaining a wide audience due to the convenience of shopping online. Additionally, growth in internet friendly mobile devices such as smartphones and tablets are making e-commerce websites more accessible. Looking at the growth in e-commerce sales, many brick and mortar shops have also opened up online shopping portals to cater to the growing online retail shopping customer base. E-commerce giants such as Amazon (NASDAQ:AMZN), have also rolled out mobile apps in order to make their websites even more accessible. Deals and discounts on online shopping also encourage customers to purchase via websites rather than traditional stores. These trends are driving growth in the global e-commerce market, which in turn is boosting UPS’s package volumes.

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 1.5% decline in average yield for UPS’ U.S. Domestic Package segment. ^[1] 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. ^[2] 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).

In the holiday season, the National Retail Federation is forecasting 8-11% increase in online retail sales. For the month of December, UPS is expecting an 11% increase in e-commerce volumes. ^[3] These forecasts indicate that in the upcoming quarter, UPS could see significant growth in revenues driven by the holiday season volumes. However, it will be important for UPS to focus on its operating costs if it wants to see some substantial gains from the increase in revenue.

New sorting facilities, temp staff, routing software will help manage holiday season volumes

In anticipation of the high package volume during this year’s holiday season, UPS is working towards expanding it package handling capacity. It will have 47 new, expanded or temporary sorting facilities ready in time for the peak season. ^[3] These sorting facilities will help increase its capacity by 5%. UPS has also invested in the development of around 30 new technology solutions which will strengthen its package handling capability by improving package visibility, volume forecasting and customer communications.

Additionally, UPS will be hiring 90,000–95,000 seasonal employees. ^[4] Traditionally, operations have been limited on Black Friday, however this year the company will operate for the full day. 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.

These preparations will set UPS back by $175 million in operating expense and $500 million in capital expenditure. It is because of these expected cash outflows that UPS reduced its earnings per share guidance for the year.

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1. UPS Delivers Strong 3Q Results; 3Q EPS Moves 13.8% Higher, October 24, 2014, www.ups.com [↩] [↩] [↩]
2. UPS Announces Dimensional Weight Changes, June 17 2014, www.ups.com [↩]
3. United Parcel Service’s (UPS) CEO David Abney on Q3 2014 Results – Earnings Call Transcript, October 24, 2014, www.seekingalpha.com [↩] [↩]
4. UPS Begins Hiring for 2014 Holiday Season, September 16, 2014, www.ups.com [↩]