UPS Earnings Preview: E-Commerce Growth, Dimensional Weight Pricing, Low Fuel Prices To Drive Earnings

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UPS: United Parcel Service logo
UPS
United Parcel Service

United Parcel Service (NYSE:UPS) is set to announce its second quarter earnings results on July 28. [1] We anticipate that the growing e-commerce industry will continue to drive UPS’ package volumes. We also expect to see an increase in UPS’ domestic revenue per package as a result of its new pricing mechanisms, which were implemented in the first quarter. The change in pricing mechanisms should also have a positive impact on the company’s operating margins. The decline in fuel prices will also contribute to operating margin growth by reducing UPS’ fuel bill.

In the first quarter, UPS reported a 14% increase in its first quarter earnings per share to reach $1.12, compared to consensus estimates of $1.09. [2] 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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Decline In Fuel Bill To Reduce Operating Expenses

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. [2] We expect to see a decline in UPS’ fuel bills in the third quarter as well, which should help the company’s margins. However, the decline in fuel prices will have an impact on the top line, as it will likely yield lower fuel surcharge revenues.

UPS’ Ground fuel surcharge is based on the two month lagged average price of the U.S. on-highway diesel fuel, which declined 28.5% year-on-year in the 3 months ended April. [3] UPS’ Air and International fuel surcharge is based on the two month lagged U.S. Gulf Coast spot price for a gallon of kerosene-type jet fuel, which declined 41.7% year-on-year in the 3 months ended April. [4]

Domestic Volumes To Grow On E-commerce Packages

E-commerce sales directly impact UPS’ package volume and revenue since many online retailers, such as Amazon (NASDAQ:AMZN), employ UPS’ services in order to offer their customers timely and economical delivery of products. Therefore, growth in the e-commerce industry bodes well for UPS. In 2014, U.S. e-commerce sales grew 15.4%, increasing its contribution to overall retail sales from 5.8% to 6.5%. [5] This is because online shopping is not only more convenient, but has also become more accessible due to the increase in smartphones and tablets and higher internet penetration. Most major 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.

In 2014, UPS’s U.S. domestic package volume grew 6.4% on account of 15.4% growth in the U.S. e-commerce sales. [6] U.S. e-commerce sales grew 14.5% year-on-year in the second quarter and are expected to grow around 14% in 2015. [7] This could help increase UPS’ U.S. domestic packages, which will have a positive impact on third quarter revenues.

UPS’ dimensional weight based pricing mechanism, which has been in effect since December 29, 2014, will compliment e-commerce package volume growth. [8] The change in pricing mechanism was aimed at generating higher revenues from lightweight packages that occupy a large space in UPS trucks. When charged simply on the basis of their weight, these products 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.

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 could result in a 30-50% increase in revenue per package for bulky-yet-light products ordered online such as toilet paper rolls, towels, shoes, diapers and purses. This should considerably increase UPS’ first quarter revenue per package.

UPS’ revised rates, which were effective from December 29, 2014, will also help boost the company’s top line and revenue per package. On an average, UPS increased package and air freight rates by 4.9%. [9]

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Notes:
  1. UPS To Release 2nd Quarter Results On Tuesday, July 28, 2015, UPS Press Release []
  2. UPS’s 2015 Q1 Financials, April 28, 2015, UPS Quarterly Results [] []
  3. U.S. On-Highway Diesel Fuel Prices (dollars per gallon), EIA Petroleum & Other Liquids Report []
  4. U.S. Gulf Coast Kerosene-Type Jet Fuel Spot Price FOB, EIA Petroleum & Other Liquids Report []
  5. U.S. Census Bureau Quarterly E-commerce Report, www.census.gov []
  6. UPS Quarterly Historical Income and Operating Data, February 3, 2015, UPS Quarterly Results []
  7. Retail Sales Worldwide Will Top $22 Trillion This Year, December 2014, Emarketer Newsletter []
  8. UPS Announces Dimensional Weight Changes, June 17 2014, www.ups.com []
  9. UPS 2015 Rate Change Information, www.ups.com []