When a ship’s crew in the Bering Sea contracted an intestinal illness in late 2012, United Parcel Service Inc. (UPS) flew in medicine by helicopter. It sent $9 million of flu vaccines to Laos, too, keeping them at a constant temperature for five days across 9,000 miles.
Those journeys show how far UPS is venturing beyond its signature brown delivery vans in pursuit of a $50 billion global health-care supply chain market. Seeking new business as overnight shipments slump, Atlanta-based UPS and FedEx Corp. (FDX:US) want to take advantage of annual gains in medical cargo demand topping 20 percent.
Both companies have more than doubled their dedicated health-care storage and handling space in the past five years to take advantage of a business with potential operating margins of 15 percent or higher, dwarfing industrywide operating margins that average 5 percent, according to data compiled by Bloomberg.
“This is an industry where regulation is high, the dollar value of the goods is high” and reliable delivery is vital, said Anthony Gallo, an analyst at Wells Fargo in Baltimore who rates both companies market perform. “The more specialized services around the delivery, the more margin it has. That generic brown box that doesn’t have to be there at any specific time, the margins aren’t as good.”
UPS has almost doubled health-care space over the past two years, to 6 million square feet (557,000 square meters). FedEx Corp. (FDX) has doubled its space in the past five years, and Deutsche Post AG (DPW)’s DHL added 12 percent.
UPS estimates the U.S. health-care supply chain market -- which includes ocean and air freight, warehousing, distribution and order management, plus small-package delivery and other ground transportation -- is valued at about $20 billion, almost half the global market.
FedEx, UPS and DHL all declined to provide their market share figures for health-care shipments, which vary from prescription drugs to replacement parts for magnetic-resonance imaging (MRI) machines. None of the companies break out segment results for health care.
The business grew “well north of 20 percent” for UPS in recent years and warranted doubling the square footage, Bill Hook, vice president of global strategy for UPS Healthcare Logistics, said in an interview.
The gains were driven by expiring patents on brand-name medicines that allowed generic competitors to enter the market, new health-care laws that cover millions more consumers and an expanding global middle class that can afford health care, he said.
Customers like Henry Schein Inc. (HSIC), the largest distributor of health-care products for doctors’, dentists’ and veterinarians’ offices, illustrate the potential.
The Melville, New York-based company ships 120,000 packages a day, double the amount it sent five years ago, said Gerry Benjamin, chief administrative officer.
More than 90 percent of Henry Schein’s packages are sent next-day to small and medium-sized offices that don’t have much room for inventory, making delivery reliability paramount, Benjamin said in an interview. UPS drivers take extra steps such as avoiding deliveries during lunch hour when a doctor’s office may close.
“If there is a surgery planned tomorrow and they’re expecting products, it needs to be there,” Benjamin said.
UPS probably accounts for 35 percent to 40 percent of the $7.7 billion U.S. market for health-care transportation logistics, which excludes ocean and air services, while Memphis, Tennessee-based FedEx has 20 percent to 25 percent, estimated Satish Jindel, president of SJ Consulting Group in Sewickley, Pennsylvania.
UPS may disclose more about its health-care services tomorrow when it reports first-quarter earnings.
The business is already bolstering UPS stock, which gained 13 percent this year, outpacing an 11 percent increase in the Standard & Poor’s 500 Index and a 3 percent advance for FedEx. On a price-earnings basis, UPS had a 19 percent premium to FedEx.
UPS fell 0.3 percent to $83.50 today in New York. FedEx rose 1.4 percent to $94.46 after winning all of a seven-year, $10.5 billion contract with the U.S. Postal Service to carry mail between U.S. airports.
Health care’s “double digit” growth rates will continue at a similar pace for at least five to 10 more years, said Carl Asmus, vice president of market development for FedEx’s health-care initiatives.
“When you look at sectors you would want to focus on that are growing faster than GDP, are resilient to economic downturns, are non-cyclical or counter-cyclical in terms of transportation and require a global solution -- health care meets all those criteria,” Asmus said.
High profitability heightens the allure. Pharmaceuticals, medical devices and other health products are often sent using premium overnight services and need special handling such as temperature-controlled packaging, which drives up rates.
Jindel, of SJ Consulting Group, estimated the resulting profit margins can be 15 percent and higher. Because UPS doesn’t have a stand-alone health-care unit, the higher profitability gives a boost to more than one business.
It will help drive the operating margin at the supply chain and freight unit, for example, from 8 percent last year closer to 10 percent this year and beyond, UPS has said. That business includes services such as warehousing and inventory management. Companywide, UPS had an operating margin of 14.1 percent last year, adjusted to exclude a charge for pension benefits.
Health-care deliveries also help compensate for tepid growth in UPS’s small-package unit, which comprises about four-fifths of the company’s $54.1 billion in sales and helped drive a lower full-year profit forecast than analysts estimated.
The market brings unique risks, too. UPS, FedEx, DHL and others are responsible for ensuring they aren’t handling illegal pharmaceutical shipments.
In March, UPS agreed to pay $40 million to settle a federal probe into shipments for illegal online pharmacies from 2003 through 2010, the Justice Department said.
In some cases, UPS employees knew that drugs were being sent without valid prescriptions in violation of the law, the government said. UPS also agreed to set up a compliance program to prevent such activities. FedEx is facing a similar probe.
Beyond moving medicines, UPS, FedEx and DHL pitch themselves as end-to-end integrators that can run a health-care company’s entire supply chain. Extra services include freight forwarding, warehousing and inventory management.
In 2009, UPS took over Merck & Co. (MRK)’s distribution centers, and now handles vaccines and other items in Merck’s supply chain as far away as Europe, China and Brazil.
UPS’s recent investments in health care are “not yet at a harvesting stage” and will provide revenue and profit gains for years to come, Hook said.
“This is something we can leverage well into the future,” he said.
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