United Parcel Service (UPS 2.77%) over the years has gone from being an under-the-radar beneficiary of the growth of Amazon.com and e-commerce to a potential target for Jeff Bezos' rapidly expanding company.
Investors have been concerned that as Amazon expands into shipping and logistics, it will cherry-pick some of the most lucrative, urban deliveries that in years past have helped subsidize UPS' national network. Urban deliveries tend to be more profitable than rural ones because trucks travel less between stops, making the routes more efficient.
A UPS Boeing 747-8. Image source: UPS.
But for all of the concerns, Amazon isn't what keeps UPS execs up at night. The retail giant represents, at most, 10% of total UPS revenue, and is the part of the business that tends to generate the weakest margins. And even if Amazon continues to insource its deliveries, the e-commerce growth it has inspired is creating plenty of opportunities to build business-to-consumer shipping elsewhere.
So what haunts UPS? Multiple times in recent years, the company has stumbled trying to manage the massive year-end holiday shipping rush, and this year also faces uncertainty over US plans to impose a 25% tariff on $200 billion worth of imports from China starting Jan. 1.
Here's a look at the biggest challenges facing UPS heading into year's end, and what the company is doing to avoid getting tripped up by them.
It's the most chaotic time of the year
The holiday season of late has been a nightmare for UPS, with the company attracting unwanted national headlines in 2013 after a combination of bad weather, a shorter season due to a late Thanksgiving, and UPS' failure to staff up enough to meet the flood of demand led to presents not arriving under the tree by Dec. 24. A year later, it blew the fourth quarter of 2014 in a failed attempt to overcompensate.
While things have improved some since then, UPS took a $125 million charge in the fourth quarter of last year due to shipping volumes that exceeded the company's capacity.
UPS vs FDX CAPEX to revenue (annual) data by YCharts.
Long-criticized for underspending on its network compared with archrival FedEx, UPS lately has dramatically boosted its capital expenditures on new technologies, facilities, and capacity. The company expects to spend about $7 billion this year on capex, up from $3 billion in 2016. As a result, UPS will have 22 new or renovated sorting facilities on line worldwide in time for the peak holiday shipping season, each an estimated 25% to 35% more efficient than its classic buildings.
Its new Atlanta hub, opened in October, can sort more than 100,000 packages per hour.
.@UPS's New Atlanta Super Hub Showcases Next Generation Operating Facility pic.twitter.com/OcW8CICaN0
— UPS News (@UPS_News) October 31, 2018
UPS has also added six Boeing 747-8s and three 767-300s to its fleet since last year, increasing its international capacity and freeing up smaller aircraft to add capacity on important domestic routes. And its drivers are equipped with updated mobile tools to try to speed deliveries and get more productivity out of every truck.
Despite a difficult labor environment, management on a call with analysts on Oct. 24 said it's made "great progress" finding nearly 100,000 part-time employees to work the holiday season thanks in part to its Brown Friday national job fair held in October. The company expects to carry 800 million packages this holiday season, with at least 30 million per day on at least 19 of the 21 days between Black Friday and Christmas Eve.
COO Jim Barber, speaking on the post-earnings call, said UPS believes it has the pieces in place to handle the holiday season this year:
As in years past, we expect record demand between Black Friday and New Year's Day. We have developed the most comprehensive plan ever, and it's the product of a highly coordinated effort across operations, engineering, sales, and many other parts of the UPS organization. Our plan fully considers the unique needs of those customers who, like UPS, flex their networks by up to nearly double, [to] take advantage of this important time of the year.
Tariff troubles
Even if UPS does survive the holiday season, things will not get much easier on New Year's Day. The latest round of tariffs on Chinese imports are scheduled to increase to 25% on Jan. 1, potentially causing stress to shipping lines leading up to that date and disruptions after it.
On the post-earnings call, Barber said that UPS has seen what appears to be inventory buildups and planning for tariffs ahead of the rate increase, saying, "We are working with our customers largely in Asia right now."
Working with those customers is both a chance for UPS to build relationships in a cutthroat industry, and an opportunity for UPS planners to get a heads-up on how tariffs might alter the shipping landscape. The company believes that if the tariffs, which are mostly on consumer goods, stay in place, manufacturing is likely to shift away from China over time and toward alternative low-cost locations including Vietnam, India, and Sri Lanka. If so, the net effect on UPS' business could be simply to shift demand from one region to another, and not decrease overall shipping demand.
It's tough to quantify what impact the tariffs will have on the business. UPS in recent years has attempted to grow in areas including healthcare, life sciences, and business-to-business shipping between small and midsize companies as a way to counter its exposure to consumer shipping and tariffs. But until the tariffs are in place and those businesses have time to mature, there will continue to be uncertainty in the international shipping business.
Wait and see on UPS
It's hard to argue against UPS' strategic plan, and the investments the company is making today on infrastructure and capacity should benefit it for years to come. But the stock is not cheap, trading at 16.9 times trailing earnings versus FedEx's 12.5 times trailing earnings. And the challenges the company faces in the months to come are daunting.
I'll be watching with great interest to see how UPS manages this year's peak holiday shipping season, and what becomes of the trade war going into 2019. At some point, UPS is a stock I'd like to own as a way to take advantage of trends including the shift away from traditional retail commerce and the ever-more-connected global economy.
But given the level of uncertainty about the business, I see no reason to rush in today. Leave UPS in the cart for now.
