UPS: Can It Keep Delivering?
Big Brown's bold new ventures are paying off, but cracks in its domestic shipping business are starting to worry investors
United Parcel Service's ubiquitous chocolate-colored trucks carry more than 6% of the country's goods in any one year. So when the economy tightens, as it has in the last two years, UPS (UPS
) feels the pinch. Its domestic package volume has fallen for the past seven consecutive quarters. Worse yet, the slowdown comes as the giant Atlanta-based company faces increasing competition at home and abroad.
Yet UPS has managed to prosper, landing on this year's BW50 list at No. 14. In the fourth quarter, net income jumped to $1.5 billion, or $1.32 a share. Much of that was attributed to a one-time tax credit of $776 million, but excluding that, operating earnings rose to about $670 million, up 4% from a year earlier. Not bad, considering UPS's domestic package volume fell 1.3% in the quarter.
PLOTTING A NEW COURSE. What's Big Brown's secret for success? It has spent a decade investing in new businesses in anticipation of slowing domestic shipping demand. It expanded overseas and entered logistics, the business of helping big companies manage the movement and storage of everything from automobiles to sneakers. As a result, while domestic operating income fell 9.1% in the fourth quarter, its international counterpart surged 133% -- more than compensating for the fall-off in business at home.
Such triumph in the face of adversity has helped UPS's stock outperform most of its rivals. Shares have traded recently in the mid-$50 range, or about $5 more a share than archrival FedEx (FDX
). Investors are also impressed with UPS's balance sheet: $3 billion in cash and $3.4 billion in free cash flow. "Given our strong balance sheet and simple business plan, investors see us as a safe haven," says UPS CFO Scott Davis.
But UPS shares may have peaked, at least for the moment. Some analysts, such as Gregory Burns at JPMorgan Securities, believe the company faces rising challenges. It "will underperform its peer group," predicts Burns, with volume rebounding sluggishly this year. Indeed, UPS's operating margin has sunk to 11.9%, down from a peak of 14% in 1999, when its stock first went public. Investors are already recognizing that UPS faces a rougher road ahead and have driven shares down from a high in the low $60 range last November. And its price likely could fall further. Says Burns: "UPS's stock remains expensive."
SHIPPING SLOWDOWN. UPS's greatest challenge is at home. Domestic shipping makes up 85% of operating income, but this cash cow is under attack. For one, the economy isn't growing fast enough. JPMorgan calculates that UPS's domestic package business can't grow without gross domestic product rising at a 3% to 5% pace -- and few economists expect that kind of growth in the next year. "The economy continues to bump along the bottom," agrees UPS's Davis.
In addition, FedEx's fledgling ground service is proving a serious competitor. From 1997 to 2002, its share of the domestic market grew to 11% from 7.6%. Meanwhile, UPS's share shrunk to 56.5% from 58.1%. "UPS is in the midst of a multiyear shift in market share - from it to FedEx," says Donald Broughton, a transportation analyst with A.G. Edwards & Sons.
FedEx ground got a big boost last summer. Nervous customers fled UPS during its tough negotiations with Teamster drivers. A strike was averted, but customers have been slow to return. UPS contends it has regained two-thirds of its lost customers. Others, however, are skeptical. A recent JPMorgan survey found that 60% of those who left UPS have no immediate plans to return.
RIVALS MAKE INROADS. Growth may slow overseas, too. Deutsche Post recently bought 100% control of DHL Worldwide. That has created a $21 billion behemoth with a combined road and air network similar to what UPS offers. Now Deutsche Post can offer the same one-stop shopping for transportation services as its U.S. rival. "This is a serious new competitor that will make UPS's overseas environment more challenging," says Satish Jindel, principal of SJ Consulting, a transportation consultant in Pittsburgh.
UPS downplays the merger, arguing that Deutsche Post has always been a major player. "It hasn't changed the competitive landscape in Europe," says Davis. "Deutsche Post is only doing now what we've been doing for five years. We're way ahead."
Despite these new challenges, UPS will remain a strong company and is likely a worthy holding for a long-term investor. While slowing, the international business is still growing, especially in Asia, where UPS has just entered the booming Chinese market. Davis estimates that the international share of revenue will grow to 20% from the current 15%.
LUCRATIVE LOGISTICS. And in the $3.2 trillion worldwide logistics business, UPS remains a strong competitor. It has won billion-dollar contracts, such as the one with Ford Motor (F
), to track its online inventory. Such deals pushed UPS's logistics unit into profitability for the first time in the fourth quarter. Nonpackage revenue, of which logistics is the largest business, grew 28% last year, to $2.67 billion in revenue. It now represents about 8.5% of the revenue stream.
Logistics and international shipping will keep Big Brown growing. But they're not likely to be sufficient to break an expected slide in its lofty stock price, as investors digest UPS's daunting new competitors at home and abroad.
MARCH 24, 2003
Haddad writes for BusinessWeek in the Atlanta bureau Edited By Beth Belton
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