UPS Q4 Earnings: Surge In Operating Expenses Was Expected

United Parcel Service (NYSE:UPS) released its fourth quarter results on February 3, reporting earnings in line with its announcement of $1.25 per share made on January 23. ^[1] GAAP earnings per share suffered from mark-to-market pension adjustments, to reach $0.49, compared to $1.25 in 2013. ^[2] UPS’ poor performance comes as a result of higher than expected operating expenses incurred in order to cater to the growing volumes of e-commerce packages. We believe that going forward, the surge in operating expenses due to seasonal e-commerce volumes may be countered by changes in UPS’ pricing mechanisms.

For 2015, UPS expects its earnings per share to increase 6-12%, to $5.05-5.30, with its total shipments per day rising 3-4%. UPS’ top line will likely continue to grow 5-6% on e-commerce volumes. However, revenue growth may be tempered by declining fuel costs, which may impact fuel surcharges.

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E-Commerce Packages Prove To Be Bane And Boon For UPS

The rising e-commerce package volumes helped UPS’ U.S. Domestic average daily package volume to increase 6.6%. On the other hand, this led to an increase in operating expenses by 15.9%. ^[2] The growth in package volume helped the segment’s revenue increase 7.5%, but due to the high operating costs, very little trickled down to the bottom line.

In anticipation of the high package volume for 2014’s holiday season, UPS worked hard to expand its package handling capacity. It added sorting facilities, hired 100,000 seasonal employees, invested in the development of around 30 new technology solutions and accelerated the rollout of its route optimization software, ORION, which helps reduce delivery times and costs. The preparations were expected to amount to $500 million in additional capital expenditures and $175 million in added operating expenses. However, operating expenses increased more than expected.

UPS’ compensation and benefits expenses increased 20.2% as a result of high overtime and training costs for seasonal workers and an increase in contract carrier rates. ^[2] Also, on days other than expected busy days such as Cyber Monday and December 22, most of UPS’ network remained idle, leading to a decline in productivity.

Peak-Based Surcharge, Dimensional Weight Pricing

In order to avoid a surge in its operating expense during peak seasons, UPS will be implementing a season based surcharge, with deliveries made on peak days carrying a higher surcharge. ^[3] The impact of this change will be limited to UPS SurePost and residential packages. However, the benefits of peak-based surcharges will not be realized immediately, as UPS will be implementing this change over the course of a few years as it renegotiates contracts when they are due.

Base level improvements in operating expenses will likely be driven by UPS’s move to a dimensional weight-based pricing mechanism. On June 17 2014, UPS announced that it would be applying dimensional weight pricing for all Ground packages in the U.S. and Standard packages to Canada. ^[4] Instead of charging for a package simply based on its weight, UPS will be charging its customers on the basis of dimensional weight, which can be calculated by multiplying the length, breadth and height of the package, and then dividing by 166. The change in pricing mechanism could result in a 30-50% increase in package shipping costs for bulky-yet-light products ordered online such as toiler paper rolls, towels, shoes, diapers and purses. These packages occupy a lot of space in trucks but fetch lower revenues due to their light weights. The new pricing mechanism allows UPS to charge a fair value for its most important asset, the space in its trucks, and also more efficiently cover operating costs. This should help drive improvement in the company’s revenues and margins in 2015.

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1. UPS Announces Expected 4Q Results, January 23, 2015, www.ups.com [↩]
2. UPS’s 2014 Q4 Financials, February 3, 2015, www.ups.com [↩] [↩] [↩]
3. United Parcel Service’s (UPS) CEO David Abney on Q4 2014 Results — Earnings Call Transcript, February 3, 2015, www.ups.com [↩]
4. UPS Announces Dimensional Weight Changes, June 17 2014, www.ups.com [↩]