UPS (NYSE:UPS), the world’s largest package delivery company, is expecting to ship more than 120 million packages in the week before Christmas. The predicted 6% increase in holiday deliveries will be driven by a flurry of last-minute online shopping, and with domestic operating margins up 13.1% it should bring good tidings for investors. The expected increase in consumer spending also bodes well for FedEx (NYSE:FDX). Our analysis follows below.
E-Commerce Increases Pace of Holiday Rush
Before the advent of e-commerce, American consumers were more likely to spread out their festive shopping between Thanksgiving and Christmas. Their conscientiousness was motivated by little more than an understanding of the physical effort required by tracking down presents in physical stores. For better or for worse, though, online shopping has changed this behavior forever. On five of the ten days running up to Christmas 2011, UPS expects to handle in excess of 25 million packages.  That compares with just one day during the same period last year. And with the Q3 2011 daily average coming in at 12.74 million, the figure reflects a doubling of normal volumes.
Looking beyond the holiday season, our chart below shows that total domestic ground package shipments are forecast to rise steadily over the next six years. While the holiday rush contributes just a fraction of this, we believe it is symptomatic of the growth in e-commerce. Crucially, our conservative estimate presumes no change in domestic operating margins.
Operating Margins Outperformed in Q3 2011
Our $84 price estimate for UPS’ stock assumes that domestic operating margins will remain flat for the foreseeable future while shipment volumes rise. However, operating margins rose 13.1% during the last quarter on the back of higher yields, which had in turn been driven up by fuel costs and network efficiency improvements. 
As long as shipments continue rising, this parallel increase in operating margins should see the company’s stock price appreciate. Domestic ground packages alone account for 41% of our price estimate, and the trend-line below shows that even a modest increase in their EBITDA margin – from 20% to 22% by 2018 – equates to a further 7% upside on the Trefis price estimate.
Given that UPS handles goods equivalent to 6% of America’s GDP, it is worth remembering that there is significant downside risk should the economic recovery lose traction. In lieu of any macroeconomic shocks, though, we believe the company is well placed to profit from continued growth in e-commerce.
This article was submitted as part of our Trefis Contributors program. Email us at email@example.com if you’re interested in participating.Notes:
- UPS Gears Up for Holiday Logistics, UPS, Nov 7 2011 [↩]
- UPS Earnings Per Share Rise 14 Percent on 8 Percent Revenue Growth in 3Q, UPS, Oct 25 2011 [↩]