Despite being a company with a $174 billion market cap, UPS (UPS +0.27%) Is sometimes misunderstood. For example, one common line of thought is that Amazon.com's (AMZN +1.89%) expansion of its delivery network will eat into revenue and profits at UPS and FedEx (FDX +0.40%). However, the recent investor day presentations from UPS went a long way to easing investor fears. Let's take a look at why.
What the market is worried about
It's no secret that Amazon is expanding its delivery network, and that's caused some disruption at UPS and FedEx. Indeed, FedEx has ended contracts with Amazon, and UPS has had to adjust its business strategy in response -- its focus on the small and medium-sized (SMB) market for growth is one example.
The concerns aren't just about Amazon taking revenue; there's also the fear that UPS and FedEx margins will come under concerted pressure as they chase e-commerce delivery growth. Moreover, the need to continually invest in expanding their networks could constrain cash flow growth.
Image source: Getty Images.
Two reasons investors should ignore market fears
The Amazon disruption is real, but it's essential to put it into context, and I think there are two overarching reasons why investors shouldn't be too concerned about it.
The first is that there's plenty of e-commerce growth to go around. For example, UPS sees the global small package market growing at a 10% compound annual growth rate from 2020-2023 and hitting nearly $600 billion at the end of the period. Meanwhile, UPS expects the U.S. small package market to grow at an even faster rate of 12% over the same period to $195 billion.
Indeed, FedEx didn't hesitate to close contracts with Amazon even when the e-commerce giant represented 1.3% of FedEx's revenue at the time. Moreover, FedEx recently said it was implementing "volume control actions" to better match capacity with demand. It's a similar story at UPS, where CEO Carol Tome's "Better, Not Bigger" framework implies a willingness to sacrifice pure volume growth in favor of selectively targeting where UPS wants volumes to grow.
Plenty of other growth catalysts
Second, UPS and FedEx have many other growth opportunities. Touching on FedEx for a moment, the transportation company continues to grow internationally through its 2016 acquisition of TNT Express, and is moving toward seven-day home deliveries.
Moving on to UPS, during its recent investor day event management outlined the company's 2020-2023 growth targets and how it intended to get there.
|
UPS Guidance |
2023 Est |
2020 |
|---|---|---|
|
Revenue 2023 |
$98 billion to $102 billion |
$84.6 billion |
|
Adjusted Operating Profit 2023 |
$12.4 billion to $14 billion |
$8.7 billion |
|
Adjusted Operating Profit Margin 2023 |
12.7% to 13.7% |
10.30% |
Data source: UPS presentations.
There are four essential, interconnected parts to the growth plan. Probably the most important area of the "better, not bigger" framework is its plan to expand its margin at its U.S. domestic package segment (51% of operating profit in 2020 at $3.9 billion) from 7.7% in 2020 to 10.5%-12% in 2023. To get there, management plans to generate productivity enhancements through the use of technologies such as automation and route optimization while targeting growth in more profitable deliveries.
Management is also investing to take market share internationally (an area it feels UPS hasn't taken as much market share as it could), with the aim of improving operating profit in the international segment (45% of operating profit in 2020) from $3.5 billion in 2020 to $4.3 billion-$4.6 billion in 2023. As such, additional aircraft will be bought to fuel international expansion.
Image source: Getty Images.
The COVID-19 pandemic coincided with UPS specifically targeting healthcare as a growth opportunity, and that focus will continue in the future. As a result, UPS plans for healthcare-related revenue (across all three segments -- U.S. domestic, international, and supply chain solutions) to grow by 12.3% a year to at least $10 billion in 2023.
Finally, UPS continues to heavily target the SMB market as a key focus of growth. Here again, the pandemic has helped UPS, because SMB e-commerce deliveries grew enormously during the pandemic. Management estimates that the average U.S. SMB daily volume growth was 3% a year from 2016-2019, but will be 8% from 2019-2023.
Don't worry about Amazon
All told, FedEx and UPS remain well positioned to grow for many years to come. The pandemic has boosted long-term growth prospects for e-commerce and highlighted the need for cold chain distribution networks. Meanwhile, there's a lot more to e-commerce growth than just Amazon, and both FedEx and UPS have opportunities to profit by being more selective in how they generate revenue.
