UPS and FedEx:
Delivering profits from Covid September 2020

In normal times, air cargo is a relatively small part of the overall aviation business. But these are not normal times.

Over the past fifteen years air cargo accounted for an average 12% of global commercial air transport revenues and 15% of the total tonnage carried (on the assumption of being able to squeeze nearly 11 passengers and their bags into a tonne).

The average length of haul is significantly higher for freight, more than twice the average 1,900km in the passenger business, and in revenue tonne kilometre terms air cargo in 2019 accounted for around 25% of total RTK performed, down from a peak of over 30% in 2003.

Roughly half of air cargo demand is carried on dedicated freighter aircraft (and up to 80% on some trade lanes), the rest in the the belly-holds of passenger aircraft. There is always a need for dedicated freighters as some items of cargo that need to go by air are too dangerous or too large to be carried on passenger aircraft.

It is a commodity business with a large number of players, many of whom treat cargo as a generator of marginal “ancillary” revenues, and a relatively small number of savvy customers. There is a significant imbalance in the flow of goods, with some trade lanes effectively monodirectional and with high seasonality. Load factors appear relatively low at below 50% compared with passenger load factors in the 80s, but this reflects unusable space in passenger aircraft and a complicated relationship between weight, size and shape of cargo transported: dedicated freighters operate happily with load factors in the mid 60s.

About 20% of total air cargo demand in RTK terms is carried by parcel integrators (FedEx, UPS and DHL) who between them account for half the world’s dedicated freighter fleet.

The effective grounding of the world’s long haul passenger services since the outbreak of the Covid-19 pandemic has removed half of the available capacity and put a significant squeeze on supply. As the chart shows, in the three months to end July, total cargo capacity fell by over 30% year on year: a 30% increase in the use of all freight aircraft was unable to offset a near 80% reduction in belly-hold capacity.

The demand is still there, but is constrained by the capacity shortage, and as a result, load factors have climbed while prices have doubled. In July industry data shows that total available air cargo capacity fell by 31% from prior year levels, but demand (in RTK) fell by only 13.5% producing load factors upda by 11.5 points to 56.4%. The chart courtesy of IATA shows cargo yields between Hong Kong and Europe running at levels some 60% above year-ago levels. IATA’s June forecast for the industry suggests that total cargo traffic could fall by 17% in 2020 but that cargo yields would rise by 30% and total cargo revenues could grow by 8% to $111bn — 30% of total industry revenues.

Airlines have been reported as operating cargo only services on passenger aircraft by stuffing boxes on seats and into overhead bins, and even taking out seats from their widebody passenger aircraft to chase the only source of international revenue.

According to a recent article in the Wall Street Journal, Delta has been flying an average of 50 cargo-only flights a week using belly-space in its passenger aircraft, while Emirates (which has a large fleet of its own freighters) has ripped out the economy seats from ten of its passenger jets since June.

Tim Clark, Emirates' CEO, was quoted as having said: "The airline industry is still bleeding cash by the billions each month. We are taking baby steps on the path to recovery."

At the same time the WSJ points out that in the second quarter of 2020 only four of the top thirty passenger airlines worldwide recorded a profit: Korean ($90m), Asiana ($19m), EVA ($6m) and China Airlines ($92m) — entirely because of cargo.

Integrators performing

This structural undercapacity in the cargo market is providing a strong boost to the performance of the parcel integrators.

The UPS share price, which had wallowed between $90 and $110 for much of the last five years (see chart) has risen by over 60% since the beginning of the year; FedEx which had been trading around $160 for much of 2019, suffered an immediate 50% slump in the wake of the onset of the pandemic, but has since nearly tripled to over $240 approaching its all-time high seen at the beginning of 2018. Both presented stronger than expected performance in their latest quarter results and some large swings in operational data.

UPS

For the three months to end June, UPS reported revenues up by 13%, operating profits up by 7% to $2.3bn and adjusted net income of $1.8bn, some 9% higher than the prior year levels.

Through the deepening crisis it witnessed a fundamental shift in business focus towards the consumer. On domestic US operations there was an overall 23% surge in daily volumes of deliveries — primarily “ground” and “deferred” products while next day air products having been a strong area of growth in the previous eighteen months were flat year on year. But within these figures business-to-business (B2B) deliveries fell by an average 22%, while business to consumer operations (B2C) experienced a massive 65% growth year-on-year. Overall in the quarter B2C deliveries accounted for 69% of volumes.

A large element of this surge relates to the growth of e-commerce through the pandemic lockdown, and the closure of physical stores. By some estimates, online-retail sales in the US may show overall growth this year of over 50%, pushing e-commerce to account for 15% of total retail sales in 2020 up from 10-11% in 2019.

Total domestic revenues grew by 17%, but average package prices fell by 4% because of lower fuel prices and the shift to B2C, and operating profits fell slightly partly because of additional costs for dealing with coronavirus measures.

On international operations total volume in the quarter was up by 10% with export volume growing a little faster. This growth was particularly strong in Asia with volumes in May up by over 60% from prior year levels: outbound volume was up by 47% in the quarter and the company states it added some 335 additional flights above normal schedules. It also notes that the B2C trend was also very strong with a near doubling in volumes led by cross-border activity in Europe. International operating profits jumped by 26% with a near 4 point expansion in operating margins (to 22.7%).

FedEx

FedEx equally had a strong quarter. For the three months to end August total revenues also grew by 13% — to $19.3bn — but operating profits jumped by 63% to $1.6bn with a 24bp increase in margins to 8.3%. Net income in the quarter increased at a similar rate to $1.3bn.

A major element of the improved results was a strong performance in the FedEx Express package services — and particularly domestic US residential B2C e-commerce activities. While overnight envelope volumes continued to decline with average daily volumes down by 14%, there was a 6% uptick in volumes of overnight boxes and a strong 24% growth in “deferred” packages". International services meanwhile experienced a modest recovery from depths of the May quarter in “economy” and “domestic” packages (international domestic being services within countries outside the US) but average daily volumes for these were still down respectively by 12% and 2%. However, there was an acceleration in demand for international priority services with a 31% jump in average daily volumes up from an 11% growth in the previous quarter. FedEx Express generated an 8% increase in revenues to $9.6bn and a 150% jump in operating profits to $710m for the quarter.

At FedEx Ground, where the group has been investing strongly in recent years, there was also a strong acceleration in growth. Average daily package volumes were up by 30% after having risen by 10% and 25% in the previous two quarters. Yields also improved and total revenues in the division were up by 26% year on year to $7.0bn. Margins however were under pressure, partly because of additional costs related to Covid-19 protection (which came to around $100m on a group wide basis for the quarter) and operating profits grew by a mere 30% to $834m.

In the more B2B oriented FedEx Freight division, volumes were depressed with average daily shipments down by 8% and revenues by 4% to $1.8bn. Operating profits nevertheless jumped by 41% to $274m.

On the earnings call management highlighted that 96% of the growth in volumes in the current year were entirely due to e-commerce, and tried not to focus too much on how much the group is benefiting from the crisis. They emphasised that, particularly in Ground services, the growth that they had been planning on a five year time frame had been achieved in a matter of five months. In addition where internally they had been planning on seeing a domestic US market with daily package volumes of 100m a day by 2026, their forecasts suggested that this milestone would now be achieved three years earlier in 2023.

Fred Smith, founder, Chairman and CEO, modestly pointed out that “our earnings growth underscores the importance of our business initiatives and investments over the last several years, and, in many ways, the world has accelerated to meet our strategies”.

Are these trends permanent? The Covid crisis has probably accelerated changes in entrenched consumer behaviour, and e-commerce deliveries will take an elevated proportion of consumer spending world-wide. The structure of excess of demand over available capacity for global air cargo will not return to equilibrium until long haul passenger demand recovers. At the moment such a prospect seems several years away.