UPS Earnings Rise On New Pricing Mechanism, Revised Rates

United Parcel Service (NYSE:UPS) announced its first quarter earnings results on Tuesday, April 28. After a dismal fourth quarter, wherein its earnings declined 60.8% year-on-year, UPS reported a 14% increase in its first quarter earnings per share to reach $1.12, compared to consensus estimates of $1.09. ^[1] Investors were pleased with the double digit earnings growth, which helped the stock rise 3.4% on the day.

The company’s first quarter revenue grew 1.4% year-on-year, to reach $14.0 billion, tempered by foreign currency headwinds. Excluding the impact of foreign currency, the top line grew 3.6% driven by UPS’ revenue management initiatives. The company’s efforts to improve profitability and fuel tailwinds paid off during the quarter, with operating income increasing 11%, to $1.7 billion.

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.

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New Pricing Mechanism And Revised Rates Drive Package Yields

In June 2014, UPS announced that starting in December 29, dimensional weight would be used to calculate the billable price of all ground packages in the U.S. and standard packages to Canada. ^[2] Dimensional weight can be calculated by multiplying the length, breadth and height of the package, and then dividing by 166. The change in pricing mechanism was aimed at generating higher revenues from lightweight packages that occupy significant space in UPS trucks. When charged simply on the basis of their weight, these packages would generate revenues which did not justify the space they occupied. In order to charge a fair value for its most important asset, the space in its trucks, and also more efficiently cover operating costs, UPS decided to move to dimensional weight based pricing.

The shift to dimensional weight pricing helped increase UPS Ground average revenue per package by 3.1% year-on-year, which drove UPS’ U.S. Domestic Package average revenue per package by 1.3% in the first quarter. UPS’ revised rates, which were effective from December 29, 2014, also contributed to growth the company’s revenue per package. On an average, UPS increased package and air freight rates by 4.9% ^[3]

The revised rates and change in pricing mechanism more than offset the impact of a decline in fuel surcharge revenue on UPS’ U.S. Domestic Package. However, UPS’ International Package segment was hit hard due to the low fuel surcharge revenues, which led to a 5.2% year-on-year decline in average revenue per package, excluding the impact of foreign currency weakness. ^[4]

Declining Fuel Prices Helped Improve Operating Margins

In the first quarter, UPS’ operating margin improved 100 basis points primarily due to a decline in its fuel bill. As a result of the declining fuel prices, UPS’ fuel expenses fell 33.7% year-on-year.

Strong volume growth in the quarter also helped improve profitability. The company’s total shipments increased 2.8%, to 1.1 billion packages, primarily driven by growth in exports to the European region. In the first two months of the quarter, U.S. trade in goods with European Union increased 4.9%. ^[5] This helped increase UPS’ European export packages by 9.4%.

Apart from this, UPS’ profitability improvements programs such as ORION also helped the company’s operating margins. ORION is a route optimization software that is intended to improve delivery times and help reduce the distance traveled by its drivers in the U.S. by 100 million miles annually. ^[6] The company expects to implement ORION across 70% of its drive routes by the end of 2015.

Outlook

In the coming quarters, we expect to see continued growth in UPS’s top line driven by its new pricing mechanism and revised rates. The risk of decline in fuel surcharge revenues will remain, since fuel prices are likely to remain low. However, UPS’s operating expenses should benefit from the decline in fuel bill. E-commerce sales in the U.S. are expected to grow around 14% in 2015. ^[7] This will help increase UPS’ U.S. domestic packages, which will have a positive impact on volume.

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1. UPS’s 2015 Q1 Financials, April 28, 2015, www.ups.com [↩]
2. UPS Announces Dimensional Weight Changes, June 17 2014, www.ups.com [↩]
3. UPS 2015 Rate Change Information, www.ups.com [↩]
4. UPS’ First Quarter 2015 Results Press Release, April 28, 2015, www.ups.com [↩]
5. Trade in Goods with European Union, www.census.gov [↩]
6. 2014 Investor Conference AM Presentations, November 13, 2014, www.ups.com [↩]
7. Retail Sales Worldwide Will Top $22 Trillion This Year, December 2014, www.emarketer.com [↩]