UPS's $7 Billion-a-Year Spending Spree Reaches a Moment of Truth

(Bloomberg) -- United Parcel Service Inc. is investing $7 billion this year to upgrade its delivery network for the rise of online shopping. Now it’s taking the stage to tell investors what they’re getting for that money.

“They’ve got to show the markets basically, ‘Hey, we’re spending this money, but here’s the return you’re going to get. So, trust us,’ ’’ said Kevin Sterling, an analyst at Seaport Global Holdings. The more details the courier provides in an investor meeting Thursday, the better, he said.

E-commerce has dramatically changed an arena UPS has dominated since the delivery service was created 111 years ago by two Seattle teenagers. The Atlanta-based company’s answer is to hone technology, replace aging planes and trucks, and build and modernize sorting facilities. Yet after UPS announced an ambitious investment plan Feb. 1, its shares tumbled 18 percent over the following two months and have only partially recovered since then.

“They have a great network for moving packages all over the country, but the market is now saying, ‘I just want you to deliver it within New York or Chicago, and I’ll bring it to you. Can you do that?”’ said Satish Jindel, founder of SJ Consulting Group. “Their network is currently limited in doing that.’’

UPS's $7 Billion-a-Year Spending Spree Reaches a Moment of Truth

UPS also has grappled with making more single-package deliveries to homes, which aren’t as profitable as multiple shipments to businesses. While the company hasn’t provided an outlook for capital expenditures for the next few years, several analysts project total spending of about $21 billion from 2018 through 2020.

Investors on Thursday will want answers on the efficiency gains and cost savings that UPS expects to generate. The results are crucial to protecting an average operating profit margin of about 13 percent over the past five years and a five-year average return on invested capital of 24 percent, more than double that of rival FedEx Corp.

If UPS estimates savings below $1 billion, its shares will probably drop, said Sterling, of Seaport Global. “It’s hard to say on the market sentiment, but maybe $1.5 billion might be neutral and anything north of $2 billion, even $3 billion, would probably be seen as a positive surprise.’’

The shares rose less than 1 percent Wednesday to close at $123.30 in New York.

‘Playing Catch-Up’

“They’re playing catch-up to a degree to FedEx in the automation game,’’ said Rick Paterson, an analyst at Loop Capital. UPS’s capital spending was between $2 billion and $3 billion a year from 2013 to 2015. FedEx, which began its short-distance delivery service a couple of decades ago, spent an average of $5.1 billion over the past three years.

Beyond FedEx, UPS also faces a challenge from the U.S. Postal Service, which runs unprofitably. Meanwhile, Amazon.com Inc., which had an operating margin of 2.3 percent last year, is creating its own delivery service and has ordered 20,000 vans to help independent contractors to build that network. Amazon is a big UPS customer.

FedEx relies largely on contract drivers who make about $20 an hour, usually with few benefits. Amazon is following that model. UPS’s drivers belong to the Teamsters union and eventually could make more than $40 an hour plus health and retirement benefits under a five-year contract that is up for vote.

The UPS upgrade has already begun with the opening of large automated facilities in Paris and London. A ground hub started operation in Atlanta this year that will be able to process 100,000 packages an hour when it’s at full tilt. That is more than double the capacity added in all of last year.

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