UPS(NYSE: UPS) continues to struggle through a difficult period. The small package delivery market is over capacity, pressuring pricing power at a time when a weak economy is encouraging customers to shift to cheaper delivery options. It all adds up to a difficult period for UPS, and the company will end 2024 with significantly lower earnings than management anticipated at the start of the year. UPS will likely be a big winner if interest rates head lower. Here’s why.
Interest rates are affecting not only UPS’ end markets, but also its business model. CEO Carol Tome’s tenure has been characterized by her admonishment of the “better not bigger” operating framework.
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In plain English, this implies focusing on targeted deliveries rather than chasing volume growth. This approach colors the company’s structure and competitiveness in its end markets. The latter is the key to understanding why UPS needs lower interest rates. I’ll return to that point in a moment. First, a few words on the cyclical benefit of lower rates.
Package deliveries have also been cyclical, and they always will be. When the economy is doing well, more physical goods are shipped, and vice versa. As such, the weakness in the economy over the last couple of years has negatively affected delivery volumes. Unfortunately, the delivery slowdown came after the package delivery companies ramped up capacity to align with the burgeoning demand created by pandemic lockdown measures.
As management outlined during the investor day in March, the U.S. small package market has an excess capacity of some 12 million in average daily volume in 2024.
Image source: Getty Images.
It will take time for the industry to work through that overcapacity, and UPS, among others, is reducing capacity where necessary. Lower rates will spur business activity and consumer spending, leading to growth in package delivery volume, and customers will start switching back to more costly and more timely delivery options in response.
Returning to the point about the UPS business model, it’s fair to say that the “better not bigger” framework has been challenged this year. The company continued to focus on driving growth in selected end markets, such as higher-margin markets like small and medium-sized businesses (SMBs) and healthcare. Still, it’s also taken on a significant amount of relatively lower revenue per piece volume of deliveries in 2024. You can see this in the chart below, where revenue per piece continues to decline, but volumes are growing again, leading to revenue growth.
While it’s not UPS’ ideal scenario and seems inconsistent with “better not bigger,” market conditions dictate it.
Data source: UPS presentations. Chart by author.
A lower-interest-rate environment will improve overall package delivery demand and allow UPS to better align its business with its long-term strategy. There’s little management can do about its end markets, and the pragmatic approach taken in 2024 — by taking on lower revenue per piece deliveries — is a net positive under the circumstances.
With lower interest rates in 2025, UPS should be able to finesse a return to its core operating philosophy of growing in its targeted markets and hopefully improve its revenue per piece growth.
That would be a positive development, because the good news from the third quarter came from its cost-per-piece reduction of 4.1% year over year. Not only is UPS doing an excellent job of cutting costs (the company is cutting 12,000 jobs this year to reduce cost by $1 billion) , it’s also lapping the increases in costs associated with the improved labor contract agreed in 2023.
Its medium-term plan, outlined in March, calls for ongoing investments in automation and smart facilities to improve network productivity, enabling UPS to consolidate its facilities and reduce cost per piece.
Image source: Getty Images.
UPS has a lot to gain from a lower-rate environment: Improved pricing power, a potential improvement in revenue per piece while cost per piece is likely to be controlled, and UPS can return to focusing on higher-margin deliveries. It all speaks to a combination of revenue growth and margin expansion next year as the company recovers from a difficult couple of years.
UPS is far from perfect, and there’s no guarantee it will hit its full-year earnings expectations. But on balance, the stock looks like a good value, trading on 15.6 times estimated 2025 earnings.
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