UPS Pre-Earnings: Sharp EM Currency Depreciation Should Create Upside For International Export Services
United Parcel Service ( UPS ) will report its third quarter earnings on October 25. On a y-o-y basis, revenues for the first half of 2013 continued to slow down on account of increased migration from express air freight services to cheaper modes of transportation. Despite UPS' strength in ground services over competitor FedEx ( FDX ), operating profits remained subdued due to higher pension expenses and rising fuel costs. Prior to announcing its Q2 2013 results, the company prepared the market for a tepid performance in 2013 by cutting its earnings forecast from $4.80-$5.06 per share to $4.65-$4.85 per share.
We believe the revised earnings guidance is a combined result of the extreme currency volatility seen in emerging markets and a shift in industry dynamics. Depreciating currencies tend to create an environment favorable for exports and we expect signs of positive top line growth in UPS' international business. The international segment represents about 29% of UPS' valuation, and a boost to top line growth in this division could create a significant upside to the stock's valuation. Additionally, a strengthening U.S. dollar could have a positive impact on operating margins due to lower fuel expenses for the company. However, we expect these margins to remain steady as pension payments could increase further.
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Weak EM Currencies Should Bolster International Export Revenues
International export revenues represent approximately 74% of UPS' international revenues. This division has seen revenues grow a meager 0.1% to reach $4.45 billion in the first six months in 2013 in comparison to a similar period in 2012. Overall daily export volumes increased 4.4% during the period, driven by the shift to less premium products and strong growth along Asian trade lanes. Export demand for the first six months in 2013 increased along Asia-Europe and intra-Asia trade routes. While a part of the increase in demand is due to the strengthening in the Euro against EM currencies, a part is attributable to UPS' effort in retaining customers by providing cheaper modes of transportation like the various Ocean Freight service offerings.
We expect export demand to strengthen further in the third quarter following the sharp depreciation in emerging market currencies during July-September 2013. Constant introduction of low-priced offerings from UPS also helps in strengthening growth in its overall package volumes. Recently, the company expanded its Expedited Ocean Freight offering to Mexico as trade relations with Asian economies strengthened. We expect this trend to continue across trade lanes linking Latin America to Asia and Europe.
Medical Device Shipments, E-Commerce Remain Key Growth Areas
UPS' supply chain and freight division includes various segments such as forwarding & logistics and freight. In the first six months of 2013, revenues for the forwarding & logistics segment, which represents approximately 61% of the divisional revenues, stood at $2.7 billion in comparison to $2.9 billion from a similar period a year ago. Forwarding revenues accounted for the entire decline in revenues in the segment due to lower tonnage from reduced demand and lower rates due to industry overcapacity in key trade lanes, particularly the Asia export market. However, the logistics market marked an increase in revenues due to the increase in demand for healthcare distribution systems and mail services.
We expect UPS' supply chain business to see an uptick in revenues from the current decline supported by strong growth from the logistics division, which should offset the weakness in the forwarding division in the short term. The global healthcare devices market was worth $340 billion in 2012 and is expected to outpace growth in pharma with a CAGR of 4.4% to reach $440 billion by 2018. UPS' acquisitions in Eastern Europe and Latin America, and its expanding floor space are indicative of the company's growing focus in healthcare device shipments.
Another area of growth in addition to healthcare distribution systems is the U.S. e-commerce market. Offerings such as UPS SurePost which leverage the extensive ground delivery network of the U.S. Postal Service to provide economical business-to-consumer (B2C) solutions are expected to impart additional advantage for the company. However, online retailing major eBay ( EBAY ) reported that the U.S. e-commerce market is slowing down due to lower consumer confidence amid the recent government shutdown and debt ceiling concerns. (See: eBay Warns Of E-Commerce Slowdown, Mobile Remains A Bright Spot) According to eMarketer's September report, the U.S. e-commerce market is expected to have growth rates of 16% and 15.5% in Q3 and Q4 of calendar year 2013 in comparison to 18.4% in Q2 2013. We believe this slowdown could put a downward pressure in the short term on UPS' forwarding & logistics segment. However, long term growth prospects remain strong for the division upon recovery of the U.S. e-commerce market.
We will be revising our price estimate of $88 for UPS after the company's files its results with the SEC.
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