UPS Q3 Earnings: Softer Macro Conditions, Lower Fuel Surcharge Deliver Mixed Earnings

UPS (NYSE:UPS) released its earnings for the third quarter on October 27. Revenues were down year-over-year due to currency and fuel surcharge headwinds, but net income of $1.26 billion was up slightly. The U.S. Domestic segment saw a marginal increase in revenues by about 1.9%, despite low fuel surcharges. Operating margins came in at 14.2% (slightly down from last year) primarily due to higher pension expenses. The Supply Chain and Freight segment saw a decline in revenues, mostly due to the strong dollar, which reduced export activity in the U.S. The International segment was a saving grace for UPS this quarter, posting a 10% increase in operating profit, despite lower revenues from fuel surcharges.

UPS also reaffirmed its full year guidance to be on the higher side of the $5.05 to $5.30 range. In fact, management expects all three segments to post double digit increases in operating profit next quarter, due to a peak in volumes from holiday sales. ^[1]

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Peak Time Plans

The peak holiday season is the toughest, yet the most profitable, time for most courier companies, due to the significant volumes. Keeping this in mind, UPS has come up with some strategies to prepare for the upcoming holiday season. The company expects large volume spikes, and seems confident that it can deliver strongly.

UPS expects volumes to grow by about 10% between Thanksgiving and New Year’s Day compared to the same period last year. This spike is primarily due to the increased popularity of online shopping. The company assumes December 22 to be the “peak day,” where it expects to deliver about 36 million packages, more than twice the amount of deliveries than on a regular day. According to the National Retail Federation, retail sales in the U.S. could increase by about 3.7%, while online sales increase at a rate of 6% to 8%. In anticipation of this added demand for services, UPS plans to hire about 95,000 seasonal workers for the period.

The company has highlighted a few main areas of focus in order to improve services this season. Firstly, the company hopes to optimize its network capacity this season, and customers will be able to enjoy increased adoption of omni-channel distribution and expanded access point solutions. Secondly, UPS has decided to better their technology, while improving the automation processes at their hubs. With better automation at key hubs in Europe, the company hopes to increase efficiency, sort capacity, and cut costs. The Atlanta based company has also decided to increase the use of its ORION dispatch technology, which will help the company better cope with changing levels of volume on a daily basis. This year, it has increased the number of drivers in the U.S. equipped with the technology from 45% last year to about 70%. And lastly, UPS has decided to make some changes to its pricing policies. Apart from the dim weight charges (dimensional weight charges whereby larger but lighter packages are charged more when the volume they take up is compared to the standard weight) that were introduced earlier in the year, the company has also decided to increase surcharges on larger packages due to the additional care and handling that such packages require. These enhancements to the pricing policy will ensure that customers optimize their packaging in order to save costs, thereby helping the company move more volume per unit.

Trans-Pacific Partnership:

The Trans-Pacific Partnership (TPP) is being dubbed as the largest, most ambitious, free trade initiative in history. The proposed trade pact involves twelve pacific-rim countries which collectively account for almost 40% of the world’s GDP. Earlier in the month, it was announced that all the participating nations had reached a final agreement on the matter. It is now pending review and approval from the United States Congress. ^[2]

Unlike earlier trade agreements, there is a chapter in the agreement that primarily focuses on addressing trade barriers that disproportionately challenge small businesses. The agreement is expected to cut customs red tape, allowing faster clearance of shipments, which thereby improves reliability of delivery. The TPP could also curb government corruption by requiring the “adoption of anti-bribery and conflict-of-interest-laws,” ensuring a healthy, competitive environment. The agreement also aims at providing private entities a more leveled playing field when competing with government backed entities, by ensuring that the private entities are not regulated by government entities that are also competitors. Additionally, tariff cuts and transparency will benefit companies in all the partner countries. ^[3]

Such a deal is bound to increase volumes and efficiencies of trade. Something like this could definitely help businesses expand their networks, which in turn will benefit UPS.

So it seems that UPS is in for a very busy fourth quarter. The company is also ready to reap the benefits of its deal with Coyote Logistics that concluded in August. If things on the macro front hold up, UPS could be seeing some really high revenues as well as operating margins. Will the company outperform this quarter? It seems highly plausible.

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More Trefis Research

1. UPS Q3 Earnings Call Transcript, www.seekingalpha.com [↩]
2. China Seeks To Join TPP, www.thenewamerican.com [↩]
3. Why The TPP Is Good For Small Businesses, www.fortune.com [↩]