UPS says market conditions impact Q2 revenue

Jeff Berman, Group News Editor -- Logistics Management, 7/22/2008

ATLANTA—Current economic conditions—such as fuel costs and low consumer spending—continued to take a toll on the bottom line for UPS, with the company announcing today that income for the second quarter was down 20.9 percent —at $873 million—compared to last year.

Despite this income dip, the company said that quarterly sales revenue was up 6.7 percent compared to the same timeframe a year ago. Total revenue for the quarter increased to $13 billion from last year’s roughly $12.2 billion. And it delivered a consolidated volume of 959 million packages, which was only three million off of last year, but it experienced a 67 percent increase in fuel expenses, a reduction in volumes for premium products, and low import growth.

UPS was hit hardest in the U.S. Domestic and International Package segments. For U.S. Domestic, quarterly revenue increased to $7.71B from $7.58B from last year. But this was off-set by lower quarterly operating profit and operating margins at $0.90B (compared to $1.19B last year) and 11.7 percent (compared to 15.7 percent last year), respectively.

Average volume per day was down 1.3 percent at 13,060 compared to 13,230 compared to last year. Included in this volume decline are: a 6.1 percent decrease for Next Day Air, 2.3 percent for deferred air, and 0.7 percent for ground, said UPS.

These declines, coupled with a rapid increase in fuel costs and the impact of a two-month lag in applying fuel surcharges were the major drivers in the company’s lagging U.S. Domestic operating results, according to a company statement.

International package saw quarterly revenue increase to $2.95B compared to $2.50B a year ago, and average package volume per day rose to 1.93M from 1.80M. But operating profits shrunk to $407M from $475M, and operating margin dropped to 13.8 percent from 19.0 percent. UPS said these numbers were impacted by fuel costs, declining U.S. import volume, and slower growth in premium services in the major regions of the world.

UPS’ Supply Chain and Freight segment had a solid quarter, with revenue at $2.34 billion—compared to $2.11 billion last year—and operating profit up $50M to $148M, and operating margin up 1.7 percent at 6.3 percent year-over-year.

Satish Jindel, president of SJ Consulting, told LM that the problems UPS experienced in package volume throughout the quarter is not surprising. He said it is due in large part to the pricing gap between its ground and express products. As an example, Jindel said that for a 15 pound package to be shipped via UPS Next Day air service versus Ground between New York and Philadelphia, Ground would cost $7, but standard Next Day air service would cost $36, of which almost $9 goes to a fuel surcharge.

“The fuel surcharge alone for Next-Day air service is costing more than the total shipping charge on Ground,” said Jindel. “This is something that a lot of people are not paying enough attention to.”

And based on SJ Consulting data, Jindel explained that more than 18 percent of UPS’ Next Day Air service packages are subject to that conversion.

The issue of a lag for when surcharges are applied is a major component regarding UPS’s quarterly performance, said Jindel. On the parcel side, he said the fuel surcharge is changed monthly, and UPS prefers to give customers a 25-day advance notice for when the fuel surcharge will be increased. But for its LTL unit—UPS Freight—he said fuel surcharges are changed every week.

“Why can’t they do that on the parcel side to minimize [the impact] and bring it into more alignment with the fuel prices they pay on the street,” asked Jindel. “They should update the fuel surcharge for parcel to weekly so it is consistent with LTL so customers are not faced with that challenge and make it easier on themselves.”

UPS said in its analyst earnings call earlier today that it has improved ground transit times significantly over the last two-to-three years, which is aiding its conversion from express to ground. Jindel said that if this the case, there is a question as to why UPS is not taking a larger increase on its ground service—through its annual rate increase—in order to recapture that improvement in ground service for tens of thousands of lanes UPS services.

 "Slow U.S. economic activity and fuel price increases hit us and our customers during the quarter," said Kurt Kuehn, UPS's chief financial officer, in a statement. "Even though economists do not predict a recovery until 2009, we anticipate that the second half of 2008 will generate modestly better results than the first half, assuming business conditions do not worsen.”

But in order for that to happen, Jindel said that fuel prices need to stabilize or decrease He also the May announcement in which DHL and UPS said they are working on a ten-year, $10 billion agreement for UPS to provide airlift for DHL Express U.S. domestic and international shipments from airport-to-airport within North America will also be a factor, depending on what DHL experiences in terms of any market shift during this transition period. The UPS-DHL deal is expected to be completed later this year.

“The company's pending multi-year contract with DHL, if signed as advertised should help mitigate any reduction in aircraft capacity utilization (thereby protecting margins) seen from shippers trading down in service from air to ground,” said Stifel Nicolaus analyst John G. Larkin in a research report.