Give UPS a Get-out-of-Jail Free Pass

UPS' inability to handle the larger-than-expected delivery volumes over the holidays was to a large extent not the company's fault, as the situation was rather exacerbated by foul weather. The company remains a sound investment, and expects to make impressive top and bottom-line gains in fiscal 2014.

Feb 15, 2014 at 7:00AM

Shares of United Parcel Service (NYSE:UPS) have headed steadily lower as disgruntled investors who were displeased by the company's 'less-than-adequate' handling of a last-minute surge in holiday shipments punished the company. FedEx (NYSE:FDX) was also plagued by similar problems, and its shares have not been spared from the sell-off either.

The delivery delays that plagued both companies largely came as a result of factors that were beyond the carriers' control. Higher-than-expected freight volumes flooded their networks as Cyber Monday set a new record with a huge 20.6% jump in online retail sales compared to the same period in 2012. According to IBM Digital Analytics, online sales in the final weekend prior to Christmas surged a dizzying 37.5%.

Although the carriers bore the brunt of the criticism, many of those tardy deliveries were not their fault in any way. Several industry experts, including Jerry Hempstead of Hempstead Consulting, pointed out that inclement weather, such as the severe snowstorm that hit the South and East and struck UPS' large hub in Louisville and FedEx's hub in Memphis, Tennessee, was the main culprit. Mr. Hempstead spent decades as a company executive at Airborne Express and DHL. According to him, foul weather does not stop shipments from coming in, yet the trucks that are supposed to deliver the goodies to customers cannot get to their locations, which leads to an overloaded network.

Quick response
UPS responded quickly to the logistical disaster by adding 55,000 temporary workers, while FedEx took on an extra 25,000 workers. UPS also chartered 23 more planes and a fleet of extra trucks to manage the huge surge. 

Investors should not forget that both companies suspended their service guarantees for the period spanning December 17- 26. Bad weather cancels any guarantees specified in the tariffs. Some e-tailers, such as Amazon (NASDAQ:AMZN), were exceptions to this trend and made unconditional delivery promises through Christmas, including guarantees on orders placed as late as 11 pm on Dec. 23.

E-tailers such as Amazon are in a good position to interlink their systems so that any information about potential delays is available to all of them in good time. Most brick-and-mortar retailers usually do this orally, with both dispatchers and sales reps informing their customers about possible pinch points.

Many e-tailers tend to have unrealistic expectations about how well carriers can fulfill delivery commitments, especially in the event of foul weather. Although large online retailers have access to detailed information about possible events that could delay deliveries to their customers, competition in the space is so fierce that few are willing to divulge this kind of information to their customers and risk losing sales to their competitors.

Amazon will of course be keen to avoid a repeat of this situation in the future, as otherwise customers could quickly cut their ties with the company and start patronizing physical stores for their Christmas shopping. Nevertheless, it's highly unlikely that Amazon will stop doing business with UPS because of the latest let-down. In all honesty, it would not be rational to expect UPS or FedEx to invest billions of dollars to ramp up their delivery fleets and buy hundreds of new delivery trucks that will only be used for one month of the year. In-sourcing some of the deliveries during peak months looks like a viable option for Amazon. Maybe its drones will help handle some of the excess volume spikes in the future.

Amazon's growth favors UPS
The phenomenal growth in Amazon's business, as well as the secular trend of increased online shopping by consumers, has been playing into UPS' hands. UPS is a major force to reckon with in executing ground deliveries in both the U.S. and Europe. The inexorable rise in global trade is also growing UPS' business admirably. UPS and FedEx are recognized as the true leaders of the space, and they occupy a huge moat that would be very difficult to unsettle. Any start-up willing to go head-to-head with these two behemoths would be looking at huge capital expenditures to purchase massive delivery fleets and manage intricate delivery logistics.

Huge volumes hurt profitability
UPS' overwhelming Christmas volumes resulted in a hit to its bottom line, with fourth-quarter 2013 net income tumbling by 8.7%. Consequently, UPS' shares fell 5.35% to $1.25. Revenue improved modestly by 2.8% to hit $15 billion, aided by growth in both the company's U.S. and international package segments.

Revenue per package fell due to lower fuel surcharges as well as an increase in the demand for UPS' low-margin services. The firm's cost-sensitive SurePost service grew by more than 30% as shippers chose lower cost at the expense of fast deliveries. UPS expects its domestic average daily volumes to improve by a modest 3%-4%, which means that unless the weather decides to act up during the year, investors are not likely to see a repeat of the Christmas fiasco.

Despite the setback, UPS' management reiterated its earlier guidance for EPS to be within the $5.05-$5.30 range in fiscal 2014, which represents a healthy 11%-16% bottom-line growth. UPS has been steadily increasing its dividend over the years. The stock now yields 2.6%.

UPS has also been busy buying back its shares, and its shares outstanding have been steadily falling.

Final thoughts
UPS showed good handling of a challenging supply chain problem that could easily have crippled a smaller company. The company expects its revenue and profit to grow significantly in fiscal 2014 driven by higher international export shipments and a surge in online shopping. It might not be long before the shares rebound. Hold on to shares of UPS.

Joseph Gacinga has no position in any stocks mentioned. The Motley Fool recommends, FedEx, and United Parcel Service. The Motley Fool owns shares of Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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