As United Parcel Service (UPS 1.13%) moves into its critical fourth-quarter, it's a good time for investors to take stock on what kind of year it's been and how UPS shaping up for the future. In the near-term, the company's focus is on dealing with peak demand during the holiday period, and the likely impact of slower economic growth. Thinking longer term, the question is how will it affect UPS's business and its earnings expectations? Here are five things management had to say on such issues during the recent third-quarter earnings call.
Peak demand is rising
I've previously discussed the company's plans to deal with peak, and how the changes it has made -- such as the shift to dimensional weight pricing and network capacity expansions -- are structural to UPS's business in the linked articles. It's clear from Chief Commercial Officer Alan Gershenhorn 's commentary that UPS is expecting heavy peak demand this year. "We expect to complete about 10% more deliveries compared to the same period last year. And then on our planned peak day, Dec. 22, we are scheduled to deliver about 36 million packages worldwide -- more than twice a typical day," he said.
Later on, CEO David Abney disclosed just how much extra demand is generated on peak demand days. "Prior to this big growth in B2C e-commerce, our average peak day was increasing volume, somewhere around 50% over a typical day," said Abney. "Now with e-commerce, last year we approached 75% over."
It's not hard to see why UPS has been forced to make structural changes in order to deal with increases in peak demand.
Lower fuel surcharges and currency effects took a toll
Overall revenue declined slightly to $14.2 billion in the third-quarter, but management pointed out that a combination of lower fuel surcharges -- UPS adds a surcharge on deliveries based on the price of jet fuel -- and foreign currency effects significantly reduced revenue and profitability. According to CFO Richard Peretz, "Reported revenue was slightly low in the third quarter. Top line revenue growth was reduced by about $700 million as a result of the year-over-year currency and fuel surcharge changes."
In other words, with jet fuel prices constant, revenue would have been 4.5% higher on a constant currency basis.
Volume growth will return in the fourth-quarter
UPS Ground's volume growth went negative last quarter for the first time since the start of 2011, and investors have cause to be concerned. It's important because Ground revenue represents around 70% of total revenue.
Part of the contraction in Ground volume in 2015 was due to the wide-scale implementation of dimensional-weight pricing -- where packages are priced based both on dimensions and weight rather than just weight -- but declining volumes are still a concern.
DATA SOURCE: UNITED PARCEL SERVICE PRESENTATIONS
However, CFO Richard Peretz predicted that overall "in the U.S., we expect higher average daily volume growth in the fourth quarter to be around 4% to 5%." When questioned by Merrill Lynch analyst Ken Hoexter about how volume growth could be forecast to bounce back so quickly, Peretz explained, "you have B2C that looks like it's going to have a solid quarter. E-commerce is still expected to be strong."
Long-term growth target is still valid
Given the difficulties that UPS has faced in dealing with peak demand during the last two years, and its disappointments on earnings, some investors might be skeptical about management's long-term EPS growth target in the range of 9% to 13%. Indeed, Susquehana analyst Bascombe Majors asked for clarification on the subject.
In his reply, Peretz explained that the guidance range reflected the variance in the economy and argued that the target was still applicable. "At this point, given everything we are doing internally to create network efficiency and manage and ensure that our cost and revenues are aligned properly as we see a structural change in some of the volume mix, we think the range is appropriate," he said
Detailed guidance looks solid
Finally, here's an outline of UPS's guidance:
- Full-year EPS to come in at higher end of guidance of $5.05 to $5.30
- Operating profits expected to increase at double-digit pace in all three segments
- U.S. average daily volume to increase by 4% to 5% in the fourth-quarter
- Fourth-quarter operating profit is expected to hit its highest growth rate of the year, in the low double digits
- International package segment volume will be flat in the fourth-quarter year-over-year
- Supply Chain & Freight segment revenue expected to grow between 7% and 9% in the fourth-quarter compared to the same period last year
In conclusion
Management made confident remarks with regard to dealing with peak demand, but UPS needs to deliver in the fourth quarter. Lower fuel surcharges and currency effects have reduced growth in 2015 -- factors that could abate going forward. Meanwhile, volume growth is expected to bounce back in the fourth-quarter -- something to look forward to.
Turning to valuation matters, management guided investors to the top-end of its full-year forecast and outlined why its long-term growth expectations remained the same. Investors will be hoping the company has no hiccups this time around in its key fourth quarter, because all valuation models will go out of the window if UPS can't deal with peak demand.
