International Operations To Support Growth For UPS Despite Short Term Currency Headwinds

The rising fuel cost has negatively impacted the logistics and transportation industry, which in turn has lowered top line growth for logistics operator United Parcel Service (NYSE:UPS). The company’s overall revenue growth slowed down to 1.9% in 2012 compared to 10% in 2011. While recovery in the U.S. economy helped UPS’ domestic operations expand by 3.6% last year, its international package business shrank by 1% during the same period on account of currency fluctuations.

In 2013, UPS’ stock price has climbed by  25% YTD as U.S. domestic operations continued to see faster growth. For the first half of 2013, revenues from U.S. operations grew 2.8% over H1 2012 compared to 1% for international operations over a similar period. Strength in cheaper modes of transportation is expected to provide an advantage for the company over competitor FedEx (NYSE:FDX), as customers look to lower transportation costs in a weak global macro-environment.

Our price estimate of $87.98 is in line with the current market price of $88.93. Despite UPS’ bleak performance in international markets last year, we believe that the growth potential in emerging markets will help UPS re-accelerate growth in its top line in the future. The company derives close to 30% of its valuation from international operations as per our estimate, and thus its performance outside the U.S. can have a significant impact on its stock price.

Emerging markets are expected to see a reversal in trade patterns in the future, with imports growing faster than exports. However, the growth rate for these markets would still outpace developed markets and logistics’ operators benefit from an increase in both forms of trade. ^[1]

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UPS’ Focuses On Expanding Its International Footprint; China Remains A Key Market

Although Europe makes up more than half of the company’s 29% revenue share from international operations, the fast-growing economies of Asia-Pacific and Latin America offer long term, high-growth potential in domestic delivery markets. This is supported by the fact that the Chinese, Indian and Latin American GDP rose 7.4%, 5.5% and 3.2% respectively, in comparison to 2.1% in the U.S. and -0.4% in the European Union during the same period.

In the Asia-Pacific region, China’s domestic delivery market holds huge potential. FedEx forecasts it to grow fivefold to $26 billion in 10 years starting 2011. The country’s burgeoning e-commerce market will drive growth of the delivery business. ^[2] However, there is strong competition from local players in the Chinese logistics’ space which combined with stringent regulations for international players can hinder UPS’ growth trajectory in the region. ^[3]

In anticipation of an increase in export demand in the country, UPS opened two new contract distribution facilities in China in August 2013. One of the two distribution facilities is 47,000 square feet in size and is located in Chengdu, an important economic center in Western China. The other facility is located in Southern China in Shanghai, close to UPS’s international hub at the Shanghai International Airport. ^[4]

We expect UPS’ international export package revenues to increase from $9.03 to $9.26 billion over our review period.

Acquisitions In Costa Rica Boost Footprint In Rapidly Growing Healthcare Logistics’ Market

Recently, the company announced its plans to acquire two Costa Rican logistics companies specializing in shipping medical equipment. ^[5] Not only will the move give the company an opportunity to have a stronger foothold of the Latin American domestic delivery market, but medical transportation services offer fatter margins. Shipping medical devices and equipment often requires specialized handling and is the reason why shipping companies can charge a premium for such services. ^[6]

The company’s management believes that the healthcare logistics segment holds a huge potential. In India alone, the logistics industry is growing at 15% y-o-y and the healthcare logistics’ market is expected to grow at three times the rate of the logistics’ market. ^[7] The company has also introduced various new freight shipment services in the past two months, with a temperature-sensitive service being the latest. This service is aimed at companies intending to transport cold chain temperature-sensitive products such as specialty pharmaceuticals and medical devices. ^[8]

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1. Emerging market consumers drive shift in trade patterns, hsbc.com, July 2012 [↩]
2. FedEx, UPS Get a Toehold In China’s Express Delivery, September 10, 2012, wsj.com [↩]
3. Private-Equity Firms Bet on China’s Logistics Sector as Consumption Booms, September 2013, The Wall Street Journal [↩]
4. UPS Expands Logistics Reach to Meet Emerging Demand in China, UPS Investor Relations, August 2013 [↩]
5. UPS to Purchase Two Costa Rican Companies; Boosts Customer Access to Global Markets, UPS Investor Relations, September 2013 [↩]
6. UPS Bulks Up in China, June 11, 2013, The Wall Street Journal [↩]
7. UPS bets on logistics solutions for auto, healthcare to drive growth, September 2013, mydigitalfc.com [↩]
8. UPS Introduces New Shipment Service Levels For Its Temperature True Portfolio, UPS Pressroom, October 2013 [↩]