U.S. Domestic Packages Will Help Lift UPS Results

 |  About: United Parcel Service, Inc. (UPS)
by: Trefis

United Parcel Service (NYSE:UPS) is set to announce its first quarter earning results on April 25. We expect the company to post strong revenue growth from its U.S. domestic package delivery services driven by robust demand for e-commerce retail. However, as the global economy continues to grow at a sluggish pace, we expect the company’s International business to report lower yields. On the other hand, UPS’ ocean freight delivery services are expected to grow more quickly backed by strong demand for its preferred less-than-container load (PLCL) services.

E-Commerce Will Boost U.S. Domestic Package Division

The U.S. domestic package division makes up almost 60% of our estimated value for UPS’ stock. It provides time-definite, money-back guaranteed small package deliveries through its extensive network of both ground and air transportation services. Customers can choose from various offerings depending on delivery speed. Similar to FedEx (NYSE:FDX) SmartPost, UPS offers SurePost that leverages U.S. Postal Service’s extensive ground delivery system to provide economic, non-urgent small package delivery services to residential addresses throughout the U.S. On the other hand, My Choice offers a highly customized delivery solution for similar packages.

U.S. domestic package volume grew by 2.8% year over year in 2012. The volume growth was fueled primarily by continued strong growth in retail e-commerce as an increasing number of consumers are migrating to the new way of shopping; however, growth in business-to-business volume was muted reflecting the lack of growth in small and medium-size enterprises. We expect business-to-consumer volume growth to extend in the coming years backed by increasing e-commerce penetration, while business-to-business volume growth would largely depend on the improvement in the business investment environment led by reduced policy risks and strategic fiscal consolidation.

Lower unemployment rates and rising wages seen during the first quarter are expected to drive favorable product mix impact which will further enhance year-over-year revenue growth. We also forecast revenue per domestic package to be better than last year primarily due to periodic revision of base rates and fuel, residential, delivery area and other surcharges. These surcharges keep the company’s operating margins relatively immune to volatility in fuel prices and other operational uncertainties. Hence, we expect EBITDA margins to remain relatively stable over the forecast period aided by operational efficiencies.

Slower Growth in Global Economy to Drive Lower International Yields

Sluggish global GDP growth driven by policy uncertainties in the U.S., China recording the slowest growth rate in a decade and Europe’s struggle with an economic nightmare is driving feeble consumer demand globally. High debt levels in the U.S. due to low lending rates over the past years is further holding back spending as consumers prioritize debt reduction over consumption. All of these factors are responsible for the slower growth in world trade seen in 2012, and are expected to continue to have their bearing on international trade during 2013 as well.

Slower than expected trade growth has negatively impacted the global freight industry as yields have plummeted due to tough competition. Moreover, continuing shift in freight traffic from air to the sea driven by higher fuel prices is not helping the air-cargo industry at all. UPS’ International export package revenue per piece declined by 2.7% year over year in 2012, driven by shift in customer demand towards slower, non-premium delivery services. As we expect heavier, less urgent and low value per pound shipments to increasingly shift towards the sea route primarily driven by aggressive total distribution cost management by companies under current economic conditions, UPS’ International business yields are expected to remain under pressure.

Growing by Offering Viability Under Current Economic Conditions

UPS first launched its PLCL freight service in the spring of 2011, in order to provide shippers with an intermediate option between the fast air freight and the economic standard ocean freight. The company claims to provide up to 40% faster door-to-door deliveries in the U.S., with additional visibility of shipments as compared to its own standard LCL service. In slightly over two years time, the company has expanded the product’s geographic reach at a rapid pace and now supports traffic from 26 Asian ports. In addition, the company also announced expansion of its PLCL freight services to Western Europe recently backed by strong demand for the product. We expect the increasing demand for ocean freight services amid shifting customer preferences to drive higher revenues for UPS’ PLCL business.

We currently have $85 price estimate for UPS, which is in line with the current market price and will be updated based on the company’s first quarter earnings release.

Disclosure: No positions.