Does UPS have too much Amazon business?

UPS Inc. (NYSE:UPS) reported generally solid fourth-quarter operating results, though about $1.9 billion in charges for pension adjustments, network reconfiguration, and the settlement of a court fight with New York state over the alleged shipping of untaxed cigarettes weighed down its net income.

The company’s quarterly earnings per share (EPS) — adjusted for the charges — came in at $2.11, 1 cent a share higher than the $2.10 estimate from nine analysts polled by Barchart and an 8.8% rise from the 2018 fourth quarter. UPS took a $2.23 EPS charge in the quarter for the associated charges. The $1.8 billion pension accounting charge was noncash. The network reconfiguration and legal charges were accounted for after tax, UPS said.

UPS forecast a 2020 EPS range — diluted and adjusted — of between $7.76 and $8.06. The “midpoint” figure that analysts like to focus on was reduced to $7.91 per share from consensus estimates of $8.03 a share. Analysts said Thursday that the midpoint reduction was anticipated given the magnitude of the charges.

In the quarter, average daily volume rose 7.5% to 26.6 million packages. Revenue rose 3.6% to $20.6 billion. Operating profit grew 6.4%, or 13.7% on an adjusted basis, UPS said.

The results were generally in line with consensus expectations. However, some analysts raised concerns over future competition from, Inc. (NASDAQ:AMZN), which is building its own delivery network, as well as UPS handling more Amazon traffic — never known for its generous margins — than before. UPS shares fell 6.7% to close at $108 a share.

Amazon, which is UPS’ largest individual customer, in 2019 accounted for 11.6% of UPS’ $74 billion in revenue. Amazon tendered larger volumes to UPS throughout the year 2019 as Amazon and UPS rival FedEx Corp. (NYSE:FDX) dissolved their U.S. air and ground delivery partnerships.

The presence of more Amazon traffic pressured UPS’ domestic fourth-quarter yields despite the carrier posting double-digit volume gains in its next-day and second-day air services. Next-day air volumes grew by 26% year-over-year, while second-day volumes grew by 16%. However, next-day air yields fell by 13% year-over-year, and second-day yields declined by 5%, according to data from Deutsche Bank. Domestic ground volumes rose 6%, while margins fell by 1%.

UPS said it welcomes the additional Amazon traffic because it adds package density to UPS’ high-fixed cost network, thus reducing unit costs and improving the profitability of each shipment.

Tellingly for U.S. and global economies, UPS predicted continued weakness in global industrial production during 2020. Industrial economies worldwide have been in a more than yearlong funk, and there’s no indication the tide will turn until the second half of 2020, at the earliest. Mega-scale carriers like UPS are considered proxies not only for their industries but for global economic activity.

UPS said it will continue to spend billions of dollars on a four-year physical network reengineering program aimed at broadening its appeal to small and midsize businesses. Late Wednesday, it announced a slew of initiatives largely focused on facilitating logistics services for potentially high-margin small businesses that want to tap into e-commerce but lack the in-house logistics expertise to follow through.

The reengineering initiative, which involves the building of “super-hubs” and separate automated sorting facilities, is projected to add 350,000 to 400,000 pieces per hour of sortation capacity in the U.S. each year between 2018 and 2020. By the time the project is completed in 2022, all of the company’s eligible U.S. volume will move through highly automated hubs, up from 50% as of December 2018, UPS said. A sixth superhub, in Harrisburg, Pennsylvania, is scheduled to open in 2021 and will connect five major cities: New York, Philadelphia, Washington, Baltimore and Pittsburgh.

The program is expected to be accretive to earnings next year and generate between $1 and $1.20 in EPS by 2022, UPS executives said on the company’s analyst call Thursday. The bottom-line gains from the increased productivity will more than offset the significant development costs, Chairman and CEO David Abney said Thursday. Abney added that 80% of the U.S. population enjoys faster transit times today than they did when the program launched in 2018.

The domestic package segment, benefiting from a strong U.S. consumer eager to shop for the holidays, posted a 6.5% increase in revenue. Profit and margin rose in the high-single-digit ranges. Unit costs fell 2.1%, its third straight quarterly decline. UPS said it is gaining efficiency traction from its reengineering program, which is designed to boost package throughput and drive down unit costs. UPS ships 21.7 million parcels worldwide each day.

The international segment, by contrast, suffered in the quarter from top-line weakness in the U.S.-Asia trade, as well as to and from the United Kingdom, UPS said. Both lanes represent the key geopolitical flash points in the world today. Revenue fell to $3.7 billion from $3.8 billion, with exports bearing most of the top-line hit. Adjusted profits rose 3.6% year-on-year, while operating margins stayed robust at 21.2% and expanded year-on-year in the quarter.

The Supply Chain and Freight segment, which houses all nonpackage operations and the verticals business, posted a revenue decline as lower brokerage and freight forwarding revenue offset gains in its logistics and verticals business, which both posted double-digit growth year-over-year. UPS Freight, the company’s less-than-truckload business, reported that revenue for each 100 pounds shipped rose 2.5%. Revenue per hundredweight is considered a key metric of a carrier’s profitability.