UPS is continuing to adjust its international capacity in response to cyclical and systemicchanges in volume and shipping patterns, in order to reverse declines in profitability in the
second quarter.UPS CEO Scott Davis yesterday told analysts and journalists that the company’s second quarterresults reflected a combination of customer behaviour and market trends. He said business cycleswere creating short-term challenges, “but these are similar to those we have faced many timesbefore. At UPS, the key to expanding our operating profit is to adapt our integrated network andadapt our portfolio to capitalise on changing market conditions.”
He said UPS still had great prospects in areas such as B2C throughout the world, emergingmarkets, and healthcare solutions, where the company recently announced the opening of two newmajor healthcare distribution centres, in the US and China.
He said the recent customer behaviour changes were a mixture of cyclical and structural. “Customers around the world continue to put greater emphasis on costs rather than time of transit,trading down the UPS portfolio. We believe this trend is primarily cyclical,” said Davis.
“Over the last few quarters, there has been a trough in the innovation cycle. Demand for newhigh-tech products traditionally drives express small package and air freight out of Asia.”
But he added: “On the other hand, some of the trade-down is likely permanent. More internationaltrade is being conducted regionally and supply chains are becoming more efficient, so the need forthe fast express options may not grow quite as strong in the future.”
He said customers clearly saw less need for speed in a soft global environment, something thatthe company had experienced for a couple of years now. “But I do think that what gets it goingagain, what gets express going again, is innovative high-value goods. We have been in a trough; wewill come out of that trough at some point in time in the future.”
Davis admitted he was not sure when that was going to be. “But we know that there are newproduct launches coming up, new innovation coming up, innovative new products, and when thathappens you will see the express product growth,” he said. “I’m not sure you will see the expressproduct grow as fast as you did 10 years ago, unless you get stronger global economy and goodgrowth in global trade.”
But he said it was possible to overreact to apparently structural changes. “We talked five yearsago about the next-day air market in the US being a market that was going nowhere, but in the lasttwo years, we grew that market faster than the ground,” he observed.
In the meantime, he said UPS was doing a lot of product innovation and expansion, both toincrease the yield on aircraft and “to add some product capabilities in the lower arenas”.
COO David Abney outlined some of the key initiatives UPS had been working on. He said changes ineconomic cycles and consumer behaviour created challenges and opportunities, and the key tolong-term success was adapting your model to capitalise on these changes – something he said UPShad been doing more than 100 years.
“It goes without saying that we have already identified overhead and discretionarycost-reduction opportunities; I can assure you that I have an internal checklist of those items,”he insisted. “But that’s not all I want to discuss; I want to give you some insight into how UPS ismaking strategic changes to our network and portfolio to meet the evolving needs of themarket.”
He continued: “In our US domestic operations, UPS is ramping up technology implementations likeOrion, which takes route optimisation to a new level. To give you an idea of the scale of thisproject, we have assigned almost 500 people to this multi-year development.”
At the same time, he said the company was delaying some projects that don’t deliver immediateresults. “Additionally, we have identified opportunities to move more premium volume over to road,taking advantage of our Worldport capabilities and the UPS integrated network.”
To meet customer demands, he said UPS was leveraging its relationships with retail shippers todevelop more sophisticated distribution modes that better utilised their store inventory. “Theimplementation of omni-channel fulfilment is still in the early stages and we are seeing greatresults, including B2B shipment growth,” he said.
In the company’s international business, he said maximising aircraft utilisation had always beenimportant, and the company’s margins continued to benefit from the adjustments it made to itsglobal air network.
“We have already cut Asia capacity by about 20% and we will continue to reduce trunk routes andscheduled frequencies, making adjustments from Asia to the US and Europe – being mindful that wemust remain nimble enough to react to surges in demand,” he insisted.
He claimed UPS had done “a great job over the years” in managing the balance of air freightcapacity to volume trends, particularly on transpacific routes, but this was being continuallyfine-tuned.
“Since 2011, we have reduced our Asia capacity by 20%, and even this last quarter, from aninternational standpoint, with export volume up 5%, block hours were down 1.2%,” he explained. “That being said though, it is an ever-changing environment and we have to watch very closely, andfor this next quarter we plan to reduce from 8 to 7.5 trunk routes out of Asia.”
He said the company was also reducing one weekly frequency from Asia to Europe. “But we alsohave the ability to plan in advance, and when we see days that are going to have less volume, wewill shut down lanes for particular days of the week, which we are having a lot of success with. Soit is something we are actively managing.”
More broadly, he said the company was always making changes to address the risk andopportunities of a changing marketplace – for example, expanding its presence in emerging marketswith new solutions for customers.
“Notably, we have expanded our worldwide expedited service to 145 new destinations and 60 neworigins earlier this year,” he pointed out. “We now provide shippers in these emerging markets withan economical alternative to express shipping. To increase more premium revenue into our aircraft,we introduced UPS worldwide express freight. This service offers shippers in key markets guaranteedday-definite door-to-door freight options.”
In the company’s Supply Chain and Freight segments, he said UPS’s primary focus for improvingperformance was on the forwarding business unit. “To better manage our transportation purchase, we’r e implementing a system that optimises buy rates to match real-time market conditions,” heexplained. “Additionally, we are diversifying the revenue base to take advantage of the trade-downtrends in the airfreight forwarding market. UPS expanded our ocean freight capabilities, a businessthat we have been in for over a decade. For example, we extended the reach of our oceanless-than-container-load (LCL) service to hundreds of new lanes around the world.”
He said UPS’s ‘Preferred LCL’, accelerated ocean freight service had been expanded to severalkey markets in Europe. “When customers seek less-expensive freight options, UPS offers a completeportfolio of solutions,” he insisted.
He said the company expected to reduce overheads and operating costs across the entire SupplyChain and Freight segment, by using UPS technology. “Given our long history of adapting to changingconditions, and the actions I have just reviewed, we are confident that we will deliver solidsecond-half results in 2013 and beyond,” said Abney.
Looking forward at “the macro picture”, Davis said a global economic expansion for the secondhalf of 2013 was still expected, although he pointed out that economic forecasts had been loweredin 10 of the 12 largest global economies, including in the US.
“One area the US continues to struggle with is exports, especially to Europe, so UPS stronglysupports the transatlantic trade and investment partnership,” said Davis. “This is a greatopportunity for the US and the EU to set the standards for trade pacts.”
CFO Kurt Kuehn said the downgraded forecasts for many of the world’s major economies meant thatUPS had lowered its full-year earnings expectations. “While we did bring down the numbers, it’simportant to note that UPS still expects improvement,” he pointed out. “In fact, the midpoint ofour range calls for about 8% earnings-per-share growth over the second half of 2012.”
Looking at the remainder of 2013, for the US domestic segment he said UPS expected daily volumeswould increase by between 2% and 3%. “Growth should get stronger as the year progresses and as weconvert missed opportunities from earlier in the year,” he said, referring to lost sales caused bythe company’s protracted union negotiations.
“Revenue growth should be slightly higher than volume. Package characteristics and lower fuelsurcharges will continue to mask base-rate improvements somewhat and profitability will be up atthe mid-single digit base,” he said.
“For the international segment, in the back half of the year, we expect revenue and daily volumegrowth of approximately 4% to 5%. Yield improvement will be hampered by continued mix changes, aswell as commodity fluctuations.” He expected currency to negatively impact profit comparisons byapproximately $100 million. “However, we anticipate operating profit improvement in line with ourrevenue growth of 4% to 5%. Third-quarter operating profit expansion will be relatively flat, dueto comparisons with last year.”
Looking at Supply Chain and Freight for the remainder of the year, he expected revenue growth tobe flat, with an operating margin of approximately 8%, “driving mid-single-digit profitimprovement”.
Kuehn concluded: “Let me assure you that UPS is focused on both our long-term strategies and onmaking the necessary adjustments to adapt to current market conditions.”
