Can UPS Deliver in a Downturn?

It makes perfect sense that an economic slowdown should hurt a company like
>United Parcel Service Inc. (NYSE:UPS – news). After all, the package
>delivery giant is exposed to just about every segment of the worldwide
>economy — from lawyers to retailers to pharmaceutical companies. Fewer
>shipments and reduced spending on high-cost premium delivery services could
>spell trouble for UPS.

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>Hurt, it will, but the world's No. 1 package mover seems to have figured
>out how to weather the downturn better than its competitors through a
>combination of old-fashioned cost cutting and tightening of operations. The
>company met lowered expectations for the second quarter, when earnings fell
>9% to $630 million, or $0.55 per share, on revenues that edged up 3.9%, to
>$7.57 billion. Things could have been much worse. Rival Federal Express
>(NYSE:FDX – news) proved as much when its most recent quarterly net profit
>came in 54% short of last year's level.
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>Indeed, investors looking for strong cyclical plays should give UPS top
>priority. If the U.S. economy starts to turn around sometime later this
>year or early next, as economists are predicting, UPS should be one of the
>first companies to come roaring back in 2002. “We need to see a domestic
>recovery take hold. Once you see the bottom — that we're starting to move
>up — the stock should break out of [its] range,'' says Steve Raineri, an
>analyst with Dresdner Kleinwort Wasserstein. For one, AG Edwards analyst
>Donald Broughton expects the company's earnings per share to rebound to
>$2.53 next year.
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>RELATIVE STABILITY. To be sure, UPS' results this year will be lackluster.
>That's mainly because of the broad economic slowdown worldwide, though the
>falloff in e-commerce shipping in the U.S. isn't helping, either.
>Broughton, who has the most conservative earnings expectations on the
>Street for UPS, expects the company to post 2001 earnings per share of
>$2.06, down 13.7% from last year. But that's still less of a hit than FedEx
>is expected to take. Analysts, on average, forecast that its earnings for
>fiscal 2002, which ends next May 31, will plummet to around $2.05, down
>21.7% from fiscal 2001.
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>UPS shares aren't cheap. At around $58 apiece, UPS shares trade at a
>price-to-earnings ratio of 25. That's well above FedEx, which is trading
>around $41 a share and a price-earnings ratio of 20. Investors have put a
>premium on UPS for its ability to keep results from falling off a cliff.
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>UPS does have a lot going for it. For one thing, it is less exposed to the
>high-tech bust than FedEx, partly because its customer base is broader.
>Long considered the cheaper alternative to FedEx, UPS could even benefit as
>companies pare costs by shifting to less costly, slower shipping methods.
>“FedEx is more vulnerable to an economic slowdown as it is the market
>leader in express shipments and has total overnight volumes that are nearly
>double in size to UPS,'' writes Morgan Stanley Dean Witter analyst James
>Valentine in a recent report.
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>So far, UPS also is holding its own in heavy competitive warfare with
>FedEx. FedEx has been chipping away at UPS in the ground shipment business,
>where UPS' $3.9 billion in sales are nearly seven times FedEx' $580
>million. In that segment, UPS' ground revenues edged up only 2.6%, well
>behind the 6.2% increase at FedEx. On the other hand, in the express air
>delivery business, which is FedEx' forte, UPS held up better than its rival
>in the second quarter.
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>SPENDING AND SAVING. Moreover, cost-cutting measures taken at the end of
>the first quarter have already started to help results at UPS. A 200-point
>program, including a hiring freeze and cuts in business travel, has kept
>the company from having to resort to layoffs. “They've done a good job of
>quickly reducing the cost structure,'' says Bill Fisher, an analyst with
>Raymond James & Associates Inc. He notes that in the latest quarter, UPS'
>domestic revenues were up 5% while overhead costs fell $120 million.
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>Additional savings will be booked in the second half. Capital spending on
>things such as information technology, trucks, buildings, and
>package-sorting will be cut by about $300 million, to a total of around
>$2.5 billion. The easing of fuel prices, if it continues, also should help.
>Last summer, UPS responded to the higher costs by tacking on a fuel
>surcharge of 1.25%. Norman Black, a spokesperson for UPS, says the fee is
>the lowest in the industry and is temporary. “We'll remove it as soon as
>we can,'' Black says. “We historically hold our fuel expenses to 3% of
>revenue. No competitor is even close to that.'' Among UPS' fuel-saving
>measures, Black points to hedging, strict operating procedures for pilots
>and drivers, and use of satellite technology to review driving routes.
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>In the meantime, UPS is beefing up its non-package business, which
>primarily consists of logistics. It recently paid $450 million for
>freight-forwarder Fritz Companies as part of its push to expand in the
>logistics segment. It also acquired Uni-Data, a global logistics company
>based in Germany.
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>With $1.5 billion free cash flow generated in the first six months of 2001
>alone, UPS probably will continue to scoop up strategic acquisitions in
>non-core businesses, such as logistics, analysts say. For instance, it also
>recently bought private mail outfit Mail Boxes Etc. UPS' goal is to boost
>non-package businesses from about 7% of its $30 billion in annual revenue
>now, to 15% to 20% of revenue by 2007. Even without additional
>acquisitions, UPS' non-package revenue is expected to increase by around
>40% this year.
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>HIGH HOPES. UPS also continues to expand overseas. About 15% of the
>company's total revenues come from international shipping, though overseas
>revenue growth in the second quarter fell to about 6%, which is down
>two-thirds from the rate in the first quarter. The good news is that volume
>in Europe is still growing around 21%. UPS also has put significant
>resources into building infrastructure in China and other parts of Asia,
>even while Asian economies are slowing.
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>The cost of these initiatives has been pinching operating margins. “They
>made some big investments during bad economic times and it has exacerbated
>the situation,'' Fisher says. But analysts expect a payoff as early as next
>year. For instance, the logistics operation, which includes Fritz, is
>expected to show a profit in the fourth quarter. And Raineri expects the
>China operation to contribute only a small loss on some $50 million to $60
>million in revenues in 2001.
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>UPS insiders seem to have confidence in the company's long-term prospects.
>The company first went public less than two years ago, when it pulled off a
>wildly successful initial public offering. It continues to buy back shares
>in a show of management's confidence in the strategy. Employees, who own
>around 45% of the company, also are well motivated. “They all have their
>skin in the deal. That certainly helps. It keeps everyone focused on the
>right thing,'' Raineri says. And the right thing for UPS is to batten down
>the hatches while continuing investing for the future. It may hurt now, but
>when the economy turns up again, the payoff could be big.
>Yahooo