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UPS's E-Commerce Growth Is Here to Stay

By Daniel Foelber - Feb 21, 2021 at 9:43AM

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UPS's tailwinds extend far beyond 2020.

Package delivery leader United Parcel Service (UPS 0.75%) had an incredible year, posting record-high revenue and adjusted operating income. While it's easy to attribute the shipping giant's performance to pandemic-induced tailwinds, UPS is confident that it can continue to capitalize on key growth drivers for years to come.

Let's analyze what drove UPS's stock higher in 2020, and more importantly, determine if that growth was a flash in the pan or the beginning of something bigger. 

One small-business owner folds and packages clothes as another checks a laptop.

Image source: Getty Images.

SMB and e-commerce growth

One of the big growth drivers for UPS in 2020 was its ability to tap into the needs of small to medium-sized businesses (SMBs). Along with a surge in business-to-consumer (B2C) sales, SMB growth helped offset declines in B2B sales. As with healthcare, the company's success with these smaller businesses was helped by the pandemic, as everyone from established retailers to Etsy side-hustlers set up online storefronts. But its success wasn't solely due to the pandemic. Rather, UPS began ramping up its e-commerce investments in 2019 -- before the first case of COVID-19 was ever reported.

In an effort to give SMBs the same advantages as larger companies, UPS partnered with online vendors, merchants, and payment providers to form its Digital Access Program (DAP) in October 2019. The program gives SMBs tools such as order management, fulfillment, delivery services, and more to help them better serve their customers and handle logistics. The strategy is meant to differentiate UPS from other package deliverers. And it's working.

After adding 120,000 new DAP accounts in the second quarter and 150,000 in the third quarter, UPS now has over 700,000 total accounts and expects DAP revenues to reach $1 billion in 2021. DAP account growth contributed to higher SMB sales. UPS grew SMB volume by 28.5% year over year in the fourth quarter, compared to a record 18.7% year-over-year growth in the third quarter. This growth is especially meaningful considering that UPS was only able to grow larger customer sales by 4% during the fourth quarter.

Timely investments

UPS probably wouldn't have had the success it did if it hadn't accelerated investments in Fastest Ground Ever, its initiative to cut transit time by expanding its fleet and logistics services. In the second quarter, CEO Carol Tome noted that the Fastest Ground Ever expansion was initially expected to conclude investment in June 2021. By pulling forward time-in-transit investments of $750 million to 2020, UPS was able to launch the program in early November. Tome did this to tap into SMB volume, commenting:

[T]hat's a big deal because 46% of our SMB customers or potential customers tell us time in transit is the No. 1 thing on their mind. When we're done, we will be at parity or better in 20 of the 25 markets that matter in the U.S. We will reach 90% of the U.S. population in three days. 75% of the U.S. population will have Saturday delivery. And then, of course, we have Sunday delivery through our SurePost product. This matters. And why am I focusing on SMB? Because the SMB customer values our end-to-end network, and they pay us for it.

Fast-forward to the fourth quarter, and the transportation stock grew weekend ground volume by 94%; SMB volume on its Fastest Ground Ever lanes grew 40%, and revenue from its DAP program grew 360% in 2020. Tome's decision to open the pocketbook and lean into consumer trends paid off big-time. While this growth will be hard (if not impossible) to replicate in 2021, UPS remains well-positioned to grow its e-commerce business and enroll more SMBs in its Digital Access Program.

Rendering of a global map with arcs connecting various world cities

Image source: Getty Images.

2021 and beyond

By investing in SMBs, UPS is effectively diversifying its business so it isn't reliant on a few large customers. Amazon (NASDAQ: AMZN) is still the company's largest customer, comprising 13.3% of total 2020 revenue compared to 11.6% in 2019.

The big question for UPS is whether it can retain the customers it gained during the pandemic while also recovering its B2B revenue. Management believes that investing in SMBs is the right long-term decision because it involves higher-margin customers rather than low-margin, high-volume companies like Amazon. It also believes that many of its SMB customers will stick with UPS because it offers the best end-to-end network. Tome noted that she doesn't expect "e-commerce sales as a percentage of retail sales will decline," and that the company should be able to expand operating margin and achieve a higher return on invested capital (ROIC) in 2021.

In terms of investments, UPS is expecting to spend $4 billion in 2021, compared to capital expenditures of around $5.6 billion in 2020. Of that, $1.6 billion is allocated toward maintenance capex, $400 million toward long-term growth projects, and $2 billion for technology and network capabilities. Around $1 billion -- half of its technology and network investment -- is slated for international and healthcare expansion. International is the segment with the highest profit margin, and it had a breakout year in 2020. It posted record-high adjusted operating income, and earned a staggering 24.3% adjusted operating margin.

UPS paid a record-high $4.04 in dividends per share in 2020. A few weeks ago, it raised its quarterly dividend to $1.02 per share with more dividend raises potentially on the way. It currently has a dividend yield of 2.5%. With a business that's firing on all cylinders and plenty of growth prospects, UPS looks to be a safe dividend stock with plenty of upside potential.

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