In a sense, the three reasons that United Parcel Service (UPS -1.51%) could rise in 2014 can be best understood by thinking about what has, and hasn't, changed in the global economy since 2008. What hasn't changed is the inexorable rise of e-commerce sales and therefore growing ground-based Business to Consumer, or B2C, growth for UPS. However, global trade hasn't grown in line with global GDP growth since 2008 -- a big change from previous economic recoveries. These two facts come together to create challenges and opportunities for UPS; let's examine how UPS is dealing with them, and why it looks set to soar.
E-commerce growth will likely lead to volume growth for UPS
A look at some simple statistics demonstrates the increasing importance of e-commerce sales to the economy. As the chart below shows, U.S. e-commerce sales have more than doubled since 2008. In addition, e-commerce now makes up a significant share of U.S. retail sales.
U.S. E-Commerce Sales as Percent of Retail Sales data by YCharts.
All of which leads to the first two reasons that UPS can soar. First, the growth of e-commerce is likely going to lead to long-term growth opportunities for UPS. In fact, in its latest quarter, UPS reported that its U.S. domestic package revenue (62% of total revenue in the quarter) increased 5.2%, with its daily package volume in the ground sub-segment up by 8.1%.
Moreover, according to the earnings release, "ground product growth was driven primarily by lightweight e-commerce shipments" -- so it's clear that UPS is seeing the benefits of burgeoning e-commerce demand on the revenue line. Total U.S. domestic ground revenue made up 43.5% of revenue in the quarter.
UPS is investing for growth
However, it's not all plain sailing with e-commerce-based revenue. In fact, more lightweight e-commerce shipments tend to put pressure on yields, and U.S. domestic package revenue per piece declined 2% in the quarter. Ultimately, adjusted operating income for U.S. domestic packages only increased 3% despite a revenue increase of 5.2%.
In addition, increased e-commerce demand can create demand peaks that are difficult to deal with -- as many disgruntled customers discovered last Christmas. So UPS finds itself in a position where it needs to invest in order to deal with a higher volume of lower-yield packages (from B2C e-commerce), and to deal with the possibility of peak demand spikes.
However, investors shouldn't necessarily see this as a negative, because the investments should benefit the company in the long term. CEO David Abney said on the recent conference call: "UPS has been busy expanding our reach, creating supply chain capabilities, and building out our small package infrastructure. These investments are part of our long-term strategy for growth and will improve returns going forward."
The market reacted negatively to the announcement that UPS was increasing its investments. However, the overreaction could be creating a buying opportunity as productivity improvements (from the investment) could increase earnings growth in future years. In a nutshell, the second upside driver is that the market is underestimating the long-term positives behind the increased investments made.
An end to protectionism?
The third reason is best understood by considering the relatively difficult conditions that UPS and its rival FedEx (FDX -2.09%) have been working under in recent years. Ever since the recession, there has been a kind of creeping protectionism in the global economy, which Fools can read about here. The result of this is that global trade has not grown as quickly as global growth.
The following chart demonstrates how cargo revenues (a proxy for global trade growth) have trended downward since the recession in 2008.
U.S. International Cargo Revenue Ton Miles data by YCharts.
However, the more recent news has been somewhat more positive, and as this article outlines, there is reason to believe that the environment is getting better for UPS and FedEx. In addition, the latest International Monetary Fund World Economic Outlook confirms that global growth is going to be much more even in the next few years.
| Region/Country | 2012 | 2013 | 2014 Est. | 2015 Est. |
|---|---|---|---|---|
| USA | 2.8% | 1.9% | 1.7% | 3.0% |
| Euro area | (0.7%) | (0.4%) | 1.1% | 1.5% |
| Japan | 1.4% | 1.5% | 1.6% | 1.1% |
| China | 7.7% | 7.7% | 7.4% | 7.1% |
| World trade volume | 2.8% | 3.1% | 4.0% | 5.3% |
Source: IMF World Economic Outlook.
The takeaway
All told, the global trade environment looks better for UPS, and the ongoing strength in e-commerce growth should be seen as a positive. Nobody likes taking short-term earnings hits, but UPS' investment plans are in line with the need to adjust to a change in end demand. In the long term, increased volume growth (from B2C e-commerce) is a good thing, and gives UPS the opportunity to increase margins going forward due to the investments it's making right now.
