Summary
- It looks unseemly to consider buying United Parcel Service's stock that has already risen by 48% in the current year.
- SMB volume increased by ~19% in Q3 FY20, the highest growth in the segment in over a decade and a half.
- The stock is beginning to recover from the sell-off after the Q3 FY20 results announcement, and any small dips now will be a good time to buy.
It looks unseemly to consider buying a stock that has already risen by 48% in the current year, especially when the stock price has moved between long-term highs and lows in a matter of months. But United Parcel Service (UPS) today is being driven by something more fundamental than temporary blips in demand - the logistics industry is experiencing a shift in consumer behaviour, which is likely to be permanent, and the resultant change in the way businesses are operating globally. UPS, the world's leading distributor of small packages, will benefit from this evolution more than most other logistics providers. Even after the threat of COVID-19 recedes, e-commerce (and B2C deliveries) will remain a larger-than-before channel of distribution for companies across sectors, and UPS is set to reap the benefits of the development.
The company's performance in FY20 is already stronger than in the past - UPS posted revenue growth of ~16% YOY in Q3 FY20 as compared to 5% YOY in the same period of the previous FY. While the company's US market continues to remain its largest segment, international markets and freight and supply chain are the drivers now; both the latter pieces achieved their highest quarterly growth in three years in Q3 FY20. Another aspect that the pandemic has opened up like never before for UPS is the reach to small and medium-sized businesses (SMBs). SMB volume increased by ~19% in Q3 FY20, the highest growth in the segment in over a decade and a half, and the penetration in the SMB segment is only going to increase as these businesses adapt e-commerce as a standard mode of distribution and delivery.
| Q3 FY20 | FY19 | FY18 | |
| YOY Revenue Growth | 15.9% | 3.1% | 7.9% |
| YOY Operating Profit Growth | 11.0% | 11.0% | -6.7% |
Near-term growth seems nearly certain for UPS. Aside from the SMB segment, the company is expanding its cold chain reach via building on its freezer farm capacity globally, along with investing in technology for greater monitoring. These aspects will be critical to handle the anticipated surge in healthcare logistics globally once the COVID-19 vaccine becomes available.
There have been concerns about margin pressure, but being one of the largest logistics players globally cannot be for nothing. While pricing pressures on logistics providers will remain, especially now when retail consumers are sensitive about minimizing discretionary spend, UPS will likely be the last to see a lasting effect on margin. While near-term margin is expected to be squeezed by recent hiring and specific programs for improving delivery speed (Fastest Ground Ever) and catering customers over weekends, which will need investments in Q4 FY20 also, over the longer-term, the company, and its new CEO's focus on a strategy to optimize operations (Better, Not Bigger framework shared by the management), should translate to sustenance of profitability.
The management has become vocal about wanting to improve return on invested capital [ROIC], and its plan to reduce capex in FY21 also highlights the company's inward gaze in reference to returns and profitability. It is encouraging to see a behemoth looking to balance growth with optimal utilization of resources; if UPS's multi-year plan to rein in operating costs succeeds, the company's attractiveness to investors will shoot up further.
The traditional markers of attractiveness already exist in abundance - UPS is over a century old, has an irreplaceable market presence, has a significant positive cash flow from operations, the stock has a history of paying increasing dividend and at an attractive payout ratio, the company is in a sector that is among the few benefiting from the coronavirus crisis. In summary, there was very little conflict about whether the stock should be bought around March 2020 when the stock plummeted to its five-year low of ~$86, on coronavirus-related news, before recovering in the subsequent quarters. In the eight months since hitting a five-year low, the stock boomeranged by over 100% to hit its 5-year high (about ~$176 in October 2020), before some cooling off after the Q3 FY20 results.
