E-commerce challenges and opportunities in UPS’ fourth quarter

Take your pick: UPS reported either a quarter-billion dollar net loss or a one-and-a-half-billion dollar net profit for the fourth quarter of 2016.

On an as-reported basis, UPS suffered a net fourth-quarter loss of $239 million, and an operating loss of $428 million, as revenue rose 5.5% to $16.93 billion. However, after adjusting for a massive one-time mark-to-market charge for changes in the company’s pension plans, operating profit for the quarter was up 2.5% y-o-y to $2.22 billion and net income rose 1.7% to $1.43 billion.

For the full year, the picture is somewhat rosier. On an as-reported basis net income, although still positive, fell 29.2% compared to 2015, to $3.43 billion and operating profit was down a similar 28.7% to $5.47 billion, as revenue rose 4.4% to $60.91 billion. Adjusting for the impact of the pension charge, net income for the year was up 3.7% to $5.10 billion and operating profit rose 4.3% to $8.12 billion.

Turning to the operational side of the quarter, things become very interesting. The continuing rapid growth of e-commerce drove a massive increase in B2C shipments in both the US Domestic and International business segments, but this growth came at a cost. As can be seen in the chart at right, average daily package volumes grew strongly across all product lines. But, as company executives stressed several times during a discussion of the quarterly results, with that volume growth came a significant shift in product mix toward lower value products. Reflecting this shift, per-package yields either fell or were flat with 4Q15.

Looking at the results by segment, we start with US Domestic Package, where revenue increased 6.3% over 4Q15 to $10.91 billion. However, this segment took the bulk of the hit from the pension charge, and while adjusted operating profit was down only slightly (-0.6%) from 4Q15 at $1.34 billion, on an as-reported basis, that profit changed to an operating loss of $570 million.
Average daily volumes were up for all three products. Interestingly, though, while Ground volume was up 5.0% in the quarter, delivery miles rose only 0.3%. The company said this increase in delivery efficiency was the result of increased investment in IT, through the On-Road Integrated Optimization and Navigation (ORION) project. Of course, the investment required – both for ORION and for hub upgrades – has been substantial, but UPS said the gains in efficiency outweighed the cost.

The International Package segment was the star of the quarter, with strong gains in volume (up 7.3%), revenue (up 5.0%), and adjusted operating profit (up 13.1%). And, unlike the US Domestic and the Supply Chain & Freight segments, the International segment was profitable even on an as-reported basis – despite a $425 million hit from the pension charge.

The Supply Chain & Freight segment continued to struggle in what the company described as a difficult environment. Nonetheless, segment revenue increased 2.6% in the quarter to $2.68 million, and adjusted operating profit while down 10.1%, was still positive, at $179 million.

Despite the overall positive operational results, the market took a dim view, and UPS’ stock price fell 6.5% when the report was released. But, despite the impact of the pension charge on the quarterly results, a look at adjusted operating margins paints a picture of a company in good operational health. In the US Domestic segment, adjusted operating margin was 12.3% in the quarter and 12.9% for the year. In the International segment, adjusted operating margin was 21.2% and 20.0% for the quarter and year, respectively. Even in the Supply Chain & Freight segment ,margins were 6.7% for the quarter and 7.1% for the year – hardly a poor showing for a segment the company views as struggling.

Overall, UPS achieved an adjusted operating margin 13.1% for the fourth quarter, and 13.3% for the year, while adjusted net margin for the quarter and the year was 8.5% and 8.4%, respectively.