Why UPS’ Higher Margins Can Make You a Profit

Shipping and logistics is a business where capital intensity and network size really matters. The world's largest parcel delivery company, United Parcel Service (NYSE: UPS  ) , is showing its biggest two competitors, FedEx (NYSE: FDX  ) and DHL, why its business structure generates higher margins, and thus superior profitability.

Here you will see the rationale behind UPS' hard-to-match integrated global shipping network and how it managed to build the widest economic moat among all freight transportation firms.

Delivering on average 16.9 million packages per day on a global basis, UPS leads in package density. Along with its outstanding operational efficiency and extensive technology investment, this produces returns on invested capital, or ROIC that almost double its cost of capital.

The trick that explains why UPS earns higher margins than its peers has to do with the fact that the company funnels substantially greater package volume through its efficient assets. Handling greater parcel density helps reduce overall per-parcel shipping costs, but the strategic use of assets also makes a significant difference. UPS uses many of its assets to handle both express and ground shipments, earning greater margins compared with other parcel shippers, like FedEx.

Volume comparisons
If you take a look at the U.S. parcel market (the most important market by far in terms of revenue generation), FedEx handled about 8.8 million daily average parcels through its express and ground units together during fiscal 2013. UPS, on the other hand, moved 14.4 million daily in calendar 2013; this is a substantial 63% difference. If you consider just U.S. ground then the disparity is even greater, since UPS moved on average 12.1 million parcels per day and FedEx only moved about half of that (6.3 million, including SmartPost).

Integrated assets
In addition to volume superiority, the extra advantage that contributes to UPS' higher margins lies in its use of integrated assets to transport U.S. urgent and ground shipments through the same pickup and delivery network. In contrast, FedEx does not use this system and holds parallel networks of drivers and trucks. This company handles ground and express shipping separately, significantly increasing its cost structure.

There's also a convenience factor for clients, as they appreciate using the same driver to handle both express and ground packages. This is not a minor detail, as the relationship with clients adds significantly to UPS' business structure.

Hard to displace
As you probably know, the parcel shipping business requires an amount of assets very hard to replicate in the absence of sufficient package flow. Simply put, it would just be extremely costly. That's why UPS' trucks, trailers, terminals, sorting equipment, IT systems, and skilled labor become a deterrent for new competitors, which would have to endure huge financial losses during a long density-building phase.

DHL has shown that it takes at least a decade to build up to a point where it can compete with the bigger boys, and the company is still managing to make its business more efficient on U.S. soil. Unfortunately, this company still fails to displace the massive UPS and FedEx on their home turf.

Basically there are two risks that UPS faces. The first one has to do with the global and U.S. economic environment. The recent recession proved that it can generate rapid changes in shipping demand and affect profitability. The U.S. market is key, as only a fourth of UPS' total revenue comes from international sources. The good news is that prospects for American GDP growth are positive, and the country will probably grow more than last year.

The other risk is the company's high unionization. However, concerns over this risk have been mitigated in the short and mid-term due to the fact that UPS signed the current labor contract well before the expiration of the previous agreement. This minimizes potential service disruptions.

Bottom line
To sum it up, the factors that make UPS a great investment case and an amazing company to hold for long-term investment are its greater package volume, concentration on high-margin ground shipping, and use of a single network rather than parallel air and ground operations.

However, its competitors should not be underestimated, as they hold a good position and well-established brands as well.

3 stocks to own for the rest of your life
As every savvy investor knows, Warren Buffett didn't make billions by betting on half-baked stocks. He isolated his best few ideas, bet big, and rode them to riches, hardly ever selling. You deserve the same. That's why our CEO, legendary investor Tom Gardner, has permitted us to reveal The Motley Fool's 3 Stocks to Own Forever. These picks are free today! Just click here now to uncover the three companies we love. 

Read/Post Comments (0) | Recommend This Article (1)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2892290, ~/Articles/ArticleHandler.aspx, 9/5/2015 10:36:44 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

Louie Grint

I am a curious economist who likes to investigate what is behind asset price movements across the globe. My articles range from industry analysis of various sectors to understanding global macro events that could trigger volatility in the markets.

Today's Market

updated 13 hours ago Sponsored by:
DOW 16,102.38 -272.38 -1.66%
S&P 500 1,921.22 -29.91 -1.53%
NASD 4,683.92 -49.58 -1.05%

Create My Watchlist

Go to My Watchlist

You don't seem to be following any stocks yet!

Better investing starts with a watchlist. Now you can create a personalized watchlist and get immediate access to the personalized information you need to make successful investing decisions.

Data delayed up to 5 minutes

Related Tickers

9/4/2015 4:03 PM
FDX $148.61 Down -2.60 -1.72%
FedEx CAPS Rating: ****
UPS $95.30 Down -1.47 -1.52%
United Parcel Serv… CAPS Rating: ****