United Parcel Service's (NYSE:UPS) latest results indicated a return to form for the company. We've already covered the bullish case for the stock with the five key things management hopes will turn the stock around; now let's examine the bearish case.
All about e-commerce
I should admit that I'm bullish on the stock, without believing it's a screamingly good value. But every stock comes with some risk, and in the case of UPS and rival FedEx (NYSE:FDX), the key risks comes from the same place as their biggest opportunity -- the burgeoning growth in business-to-consumer, or B2C, e-commerce.
UPS and FedEx customers' requirements are changing in line with consumer demand, and that could put pressure on the businesses.
Increasing B2C e-commerce demand is increasing the height of peak demand in holiday seasons, and that could place increasing strains on UPS' and FedEx's networks.
Increasing competition for e-commerce deliveries from the U.S. Postal Service could threaten both UPS and FedEx.
Changing customer requirements
The business of online retailers, as well as cloud-based businesses such as UPS customer Amazon.com, revolves around the concept of the lifetime value of a customer. In other words, the value in winning a customer is not just about the profit in generating a one-off sale; it's about winning that customer and keeping him or her buying. In this sense, it's very important for e-commerce retailers to win new, and potentially loyal, customers with promotions and incentives such as same-day deliveries.
Unfortunately, the emphasis that e-commerce retailers put on winning new customers can result in pressure on UPS. Indeed, last Christmas UPS and FedEx were both negatively surprised by the strength of Web-based purchases -- partly caused by retailers' aggressive promotional activity.
Moreover, Amazon and Google are both expanding their own same-day delivery services to win new customers and keep them buying. For example, Google Express is expanding into D.C., Boston, and Chicago, following its debut in California last year. Meanwhile, Amazon has been expanding its own same-day delivery offering, aided by its increasing number of so-called "sortation centers." In essence, sortation centers are hubs that take Amazon orders and sort them by ZIP code so they can be delivered to local carriers -- replicating the work that UPS and FedEx do. UPS management has gone on record as stating that next-day delivery is the "real hotspot," but if Amazon, Google, and others make same-day delivery an expectation among customers rather than a novelty, then UPS may be forced to adjust its business.
Increasing peak demand leads to a disjointed business
The world knows that FedEx, and UPS in particular, had a difficult Christmas last year, and UPS has been forced to make substantial investments to avoid a similar fiasco this year. Furthermore, investors need to consider that the increase in peak demand has created a scenario in which UPS has to invest in capacity just to service a few days' demand -- something that adds to its costs.
It's unclear whether this situation will get worse in the future, but one thing is clear: UPS can't afford to disappoint customers the way it did last year.
Competition coming from the Postal Service
Where there's growth, there are probably going to be companies competing for it. In this case, the U.S. Postal Service has been cutting prices to win the business of large e-commerce companies -- an act that caused UPS and FedEx to file complaints with the Postal Regulatory Commission. The move comes at a particularly inopportune time, because FedEx and UPS are both increasing domestic pricing in 2015.
The bottom line
With growth comes growth pangs, and e-commerce is no different from any other growth industry in that regard. Investors have already seen UPS struggle with generating margin expansion as it grows its B2C e-commerce package deliveries. Furthermore, e-commerce growth is changing customers' needs, sometimes in ways detrimental to UPS' existing business.
Meanwhile, customers (and potential competitors) such as Amazon and Google have their own objective in offering their own delivery services, and the U.S. Postal Service is muscling in on e-commerce, too. This is an industry in flux, and it's not entirely clear whether UPS will face more margin pressure as a result of the changes afoot.