UPS (UPS -1.51%) is a business set to come out of a recession more robustly than when it entered it. That's not to say a recession won't hurt the company; after all, a slowdown in economic growth implies a slowing of growth in activity and, therefore, deliveries -- not good news. However, it does mean that UPS is an outstanding stock to buy should it get sold off in a market decline. It also means the stock is a super buy for long-term investors willing to ride out potential volatility. Here's why.
UPS' transformational strategy is working
The company's core U.S. domestic package business -- responsible for about 52% of income in 2022 -- is the "swing" factor in its results. UPS' transformational strategy is working, and its strategic approach is resulting in tangible improvements in its business.
The heart of its transformation strategy is a focus on growing its business in some key end markets, including small and medium-sized businesses (SMBs), healthcare, profitable expansion in business-to-business (B2B) and business-to-consumer (B2C) e-commerce deliveries, and growth in highly profitable international markets.
While the transformational strategy was launched in 2018, Carol Tome's appointment as CEO in 2020 led to the extra emphasis placed on a "better, not bigger" framework. In other words, a renewed focus on sweating existing assets and being more selective over contracts rather than chasing volume growth. But of course, this approach leaves itself open to the criticism that the best way to generate profit growth is to go for volume growth and expand margin as cost per delivery declines due to better network optimization.
The numbers add up
I believe there's evidence to suggest the UPS approach is the right way. For example, here's a look at key numbers from the U.S. domestic package segment over the last six quarters. Volume is declining, but average revenue per piece is increasing, resulting in strong revenue growth. Moreover, adjusted income from the segment is growing strongly, with a 13.4% increase in U.S. domestic package income in the first half of 2022 compared to the same period of 2021.
Despite volume declines, revenue is growing, and so are earnings.
Data source: UPS presentations.
How the strategy is working
Further insights into how UPS is achieving this came from UPS' last earnings call, where Tome outlined how "SMBs made up 29.2% of our total U.S. volume in the quarter," an increase on the 27.2% in the same quarter of 2021. UPS' growth strategy with SMBs was boosted during the pandemic as SMBs rushed to build online capability in response to the lockdown measures. In addition, UPS' digital access program (DAP) is on target to hit $2 billion in revenue in 2022. DAP is a platform designed to enhance the e-commerce capability of SMBs.
Moreover, CFO Brian Newman was clear on the main reason for the volume decline: "More than half of the decrease was due to actions we took with a few of our largest customers, to optimize air and ground volume we bring into our network."
Meanwhile, Tome addressed the issue of the e-commerce elephant in the room, Amazon.com. Due to the nature of the contractual agreement between the two, "both volume and revenue for Amazon is coming down. We project by the end of this year that Amazon revenue will be less than 11% of our total revenue," she said. However, the decline in volume from Amazon will give "room to grow in the parts of the market that we want to grow, like SMB and B2B and healthcare," according to Tome.
UPS going forward
All told, the strategy is working, and the good news is that UPS will continue implementing it. This should generate underlying improvements in profitability and earnings potential at the company. So, even if a recession slows its overall revenue growth when the economy recovers, UPS is likely to be in an even stronger position to benefit from it.
