It's been a difficult year for United Parcel Service (NYSE:UPS) investors, as they have watched their stock underperform key rival FedEx (NYSE:FDX) and the S&P 500. However, the third-quarter results saw a return to form, and investors have cause to believe that the stock can go do well going forward. Here is a look at what management wants you to know about the business, and why UPS could be a stock to buy.
What you need to know about UPS in 2014
Essentially, UPS has had a difficult year for two main reasons. First, a combination of bad weather and unexpected spikes in demand during last year's holiday season hurt its profitability in its first quarter. Moreover, UPS had to reduce its 2014 earnings forecast in July due to increasing its investment plans in order to ensure it will meet peak demand spikes in future.
Second, the relatively stronger growth in its e-commerce business-to-consumer, or B2C, packages is pressuring margins downward. B2C packages tend to be lighter and lower-yielding deliveries. In addition, UPS and FedEx are having to deal with burgeoning e-commerce delivery growth by expanding capacity -- something else to pressure margins.
The following five points from UPS' earnings call address these two issues.
Dealing with peak demand
First, going into the third quarter there was ample evidence to suggest that UPS wouldn't blow it again this Christmas, but it was good to hear added color on what the company is doing to meet peak demand this year. President of U.S. operations Myron Gray said:
In time for peak, we'll have 47 new, expanded or temporary facilities around the country. This added capacity provides the flexibility to handle higher volumes more efficiently. ... In addition, UPS has invested in the development of approximately 30 new technology solutions. These applications will improve package visibility, volume forecasting and customer communications.
Adjusting to growing e-commerce-driven B2C deliveries
The reasons that burgeoning B2C deliveries are pressuring margins have been discussed above. However, investors were greeted to some good news on the issue in the earnings call. UPS reports results out of three segments, with U.S. Domestic Package being the most important. In fact, the segment generated 64% of adjusted operating income in the last four quarters. The U.S. Domestic Package segment is also where the shift toward e-commerce B2C deliveries shows up the most.
The chart below shows the shift in adjusted operating income margin. UPS investors can see that the company delivered growth in U.S. Domestic Package margin as well as total margin for the first time in three quarters -- a strong result given that last year's third quarter saw a nice margin increase as well.
Third, CEO David Abney disclosed that UPS' B2C business had grown "up to 45% this year. One of our focuses though has been, to prepare for this trend, a lot of the technology that we have implemented has been focused around not only B2C, but B2B."
CFO Kurt Kuehn added that management would discuss its expectations for long-term B2C trends "in a few weeks" -- presumably at its analyst day presentation on Nov.13. Interested Fools should look out for coverage on that.
What about pricing?
In answering a question on pricing and its usual 2%-3% annual price increase, Chief Commercial Officer Alan Gershenhorn said the following:
This year we have been much closer to the 2%. Next year, we plan to take that up. Certainly the rate change we just announced at 4.9% for ground and air, as well as the DIM weight initiative are great examples of addressing the yields due to shifts to the lighter weights.
My previous earnings review article discusses the DIM (dimensional weight pricing) initiative in more detail. If UPS can make the 4.9% price increase stick, and encourage customers to use smaller packages (for the same weight) with dimensional pricing, then it could see some margin improvement next year.
Same-day delivery and Amazon
Amazon.com has also hit the headlines in 2014 in relation to the threat it could pose to UPS and FedEx with its drones program and, more important, the expanding number of its "sortation centers." These centers are hubs to and from which Amazon can truck items. They are particularly useful for same-day deliveries -- something that is in demand with Amazon's customers. Once an item is at the center, it can then be delivered to the customer via local post offices -- therefore bypassing UPS and FedEx.
In response to an analyst question on how Amazon's activity on same-day deliveries might impact UPS, Kuehn replied:
But we think that the majority of Internet shopping anyway happens late afternoon and evening and that the real hotspot is going to be local next-day delivery and that's something we're working very closely with a number of brick-and-mortar retailers on.
Putting it all together
All told, UPS investors can look more positively at the stock after this earnings report. Hopefully, the company has invested enough in order to avoid any problems with peak demand in this holiday season. Moreover, the increase in operating margin and the new pricing initiatives are indications that margins could grow again in future. This is a good sign, because with 45% of its business in the fast-growing B2C sector, UPS looks set to grow its top line in future years -- even if Amazon continues to invest in same-day delivery infrastructure.
Lee Samaha has no position in any stocks mentioned. The Motley Fool recommends Amazon.com, FedEx, and United Parcel Service. The Motley Fool owns shares of Amazon.com. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.