The U.S. Postal Service plans to shift daily air cargo volumes to UPS before the contract with FedEx expires in September to ensure no service interruption for customers heading into the busy holiday shipping season, the agency and company officials said Tuesday.
UPS’ (NYSE: UPS) ability to leverage its integrated air-and-ground network and bypass its main sort hub in Louisville, Kentucky, will enable the integrated express carrier to better profit from transporting domestic airmail for the U.S. Postal Service than its predecessor, executives said during an earnings briefing for analysts.
Atlanta-based UPS wrested the Postal Service’s primary air cargo business from FedEx earlier this month and is working to transition all the first-class mail, Priority Mail and Priority Express volume to its network before the FedEx (NYSE: FDX) contract ends Sept. 29, management said.
The Postal Service next month will implement a detailed plan to begin migrating the business from FedEx to UPS, spokeswoman Sue Brennan said in an emailed statement.
“The process will continue to evolve throughout the summer and be completed in advance of the contract expiration. UPS is currently an active air cargo supplier and has been moving packages for the Postal Service for many years,” she said.
CEO Carol Tomé said the U.S. Postal Service contract “fits beautifully with our strategy to grow our B2B business” and will immediately contribute to top-line growth with minimal need for additional investments. The postal contract has a five-and-a-half year minimum base term that is projected to generate about $1.5 billion in annual revenue, but analysts predict it will have a minimal contribution to earnings in the first year.
The world’s largest parcel carrier expects to support the Postal Service with existing assets and move the majority of mail volume within the current domestic daytime flight operation. It said its meshed network will allow some packages to move locally and regionally, reducing the distance traveled.
“In contrast to traditional hub-and-spoke models, we don’t have to run all of the air volume through our main air hub. Of course, we will use Worldport [in Louisville], but we will also use our regional gateways. That allows for splits to occur outside of the network. So containers will be built at origin and then we will bypass the main hub and go point to point,” said Tomé. “This is an integrated solution that’s very different I think than what the former provider offered.”
FedEx Express’ daytime flights connect through its global hub in Memphis, Tennessee.
UPS will also use its extensive ground network for packages that can be delivered more cheaply and still meet service commitments, something FedEx had limited ability to do because it ran separate Express and Ground parcel networks. FedEx, which was the Postal Service’s primary air cargo supplier since the early 2000s, was stuck with too many aircraft dedicated to daytime routes as postal volumes shrank in recent years, making it difficult to turn a profit.
The chief executive said UPS will hire fewer than 200 pilots to support the postal business but won’t need to purchase any aircraft. FreightWaves first reported that UPS was recruiting more pilots. A UPS spokesperson on April 1 said the company had job openings for 170 pilots. The union representing flight crews said it was told that more than 300 pilots could eventually be hired.
Adding Postal Service cargo volume to the existing network will improve operating and consolidated margins by increasing density without requiring extra infrastructure, sending revenue to the bottom line, management said. Most of the network costs will be allocated to the Supply Chain Solutions unit.
The contract has minimum guarantees to ensure Postal Service parcels feed the network.
UPS is working to onboard the postal volume by the peak holiday shipping season this fall. “Our operators and engineers are already planning the network to support the complete transition to UPS in the third quarter,” CFO Brian Newman said. The company is meeting weekly with the agency in Washington to smooth the transition for the busy period, added Matt Guffey, chief commercial and strategy officer.
The Postal Service contract is a nice pick up for UPS, said Tom Nightingale, CEO of AFS Logistics, which specializes in parcel, less-than-truckload, freight audit and payment, and transportation management.
“It likely is not exceptionally profitable, but is what we would refer to as ballast — keeping the ship upright. The USPS is a good-paying customer, with its predictable, consistent freight. As an intelligent pricing organization, UPS probably priced it very smartly,” he told FreightWaves last week. “They know what they’re getting into. Large government contracts such as this have plenty of transparency in the bidding process, so UPS would not be getting into this contract foolishly or haphazardly.”
Some investors remain skeptical “that a breakeven (at best) contract at FedEx became a double digit margin contract at UPS,” Morgan Stanley analyst Ravi Shanker said in a research note.
In another development related to UPS’ airline, Tomé announced that UPS last quarter launched next-day flights between Shenzhen, China, and Sydney to grow premium international business. The additional flights will speed up transit times between 11 Asian markets and Australia, mostly benefiting shippers in high tech, manufacturing and health care.
Results get better after Q1
The parcel market continues to face decreasing demand, with FedEx and UPS prioritizing operational efficiency, including large network adjustments and cost reduction.
UPS reported a sharp decline in first-quarter profit, but the results were better than expected as efficiency gains offset continued declines in parcel and freight volumes. Adjusted operating profit fell 31.5% to $1.75 billion, or $1.43 per share. Revenue of $21.7 billion was 5.3% lower than the same period last year and $180 million below analysts’ target. At least one analyst noted that expectations have been lowered so much in the past nine months that beating Wall Street isn’t a major turning point.
Management signaled in March that the first quarter would be the worst period and that results will improve as the year progresses, in part because the initial increase of the new Teamsters labor contract is being heavily absorbed in the first 12 months of the deal.
Management continues to expect earnings before interest and taxes to decline 20 to 30% year over year in the first half and grow by a similar amount in the second half of 2024. Revenue guidance for the year remains at $92 billion to $94.5 billion. The fact that guidance didn’t change after the Postal Service win suggests that th
Domestic revenue declined 5% to $14.2 billion, with operating profit plunging 43.7% to $825 million, mostly due to a 3.2% reduction in average daily volume and some softening in yields. The 5.8% operating margin beat estimates. Next Day Air and deferred air volumes fell more than 8%, continuing the shift from air to ground as customers prioritize cost savings over transit times.
UPS said the rate of decline in daily volumes slowed as the quarter progressed, ending with March volumes only down 1% year over year. Sequentially, volume declines were much better than in the fourth quarter of 2023 as the company was able to win new business.
The international business unit posted a 15.4% operating margin as a 5.8% decrease in daily volume brought revenue down 6.3%. Two-thirds of the decline came from lower domestic volumes, led by declines in Canada and Europe. Weak manufacturing in Europe helped to push down export volume by 3.6%. Asia exports were down 4.8%, an improvement from the prior quarter as shipments from China to the U.S. increased nearly 13%.
Supply Chain Solutions, which encompasses all of UPS’ nonpackage operations, saw revenues slide 5.3% to $3.2 billion, with operating profit of $132 million down 46.5% year over year. The decline was primarily due to a 15% decline in freight forwarding revenue related to the recovery of the airfreight and ocean markets.
Areas UPS is targeting for growth include premium segments such as health care, small business, returns and oversized products.
During the quarter, UPS launched a delivery service for big and bulky items, like grills and furniture, that don’t fit in the small package network through its Roadie subsidiary, a crowdsourced delivery platform. The big and bulky segment is highly fragmented and has a market value of $60 billion.
UPS was able to cut domestic operating expenses by 8% by closing 18 sort centers, lowering flight hours by 15%, eliminating about 5,400 positions and reducing purchased transportation by 17%, Newman said. The company revealed plans at Investor Day last month to close 200 sort centers over five years. Earlier this year, it said it planned to eliminate 12,000 jobs.
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