UPS in Turbulent Times: Resilience and Opportunity

Thank you, Kathy, and good evening everyone. I appreciate you giving us the opportunity to chat a little bit about the UPS story. And as you can see from my bio, the only recurring theme is I can’t hold a steady job. One of these days they’ll find a job I can hold.

The theme of your conference is very relevant to UPS because we are a company that both flies in the air and feels turbulence and we also have probably as broad a coverage of the global economy as any company you can speak of.  So we clearly are feeling these turbulent times. The theme of our recent management conference is the concept of both resiliency and opportunity – companies and investors have to be resilient and adaptive, but at the same time, opportunity abounds in today’s environment. 

Who is UPS?  Some of you might know us well.  Some of you may not.  We are a large, integrated transportation and supply chain firm with a footprint across the globe.  On any given day, we move about 2% of the world’s GDP and in the U.S., which is our strongest market, we move 6% of the GDP. So we’re a pretty broad cross-section of the economy.  We generate about $50 billion in revenues.  We have over 400,000 employees spread across 200 countries and territories.  We’re the ninth largest airline in the world, and from the technology side, which is one of our big points of differentiation; we have the world’s largest non-governmental database. So a lot of activity going on and part of our role over the last 10 to 20 years has been helping to expand the footprint of the company as global trade becomes more prevalent. 

To steal a line from Charles Dickens, UPS sees this very much like he did, although I would take away the past tense.  It is the best of times, it is the worst of times, and hopefully that’s the perspective of many of you in this room.  There’s no question it’s the worst of times.  We’re seeing dramatic declines in demand.  We’re seeing world trade patterns shift very, very radically.  Certainly we’re feeling equity pressure – dramatic declines in equity – so it’s easy to make the case that it’s the worst of times.  On the other hand for UPS, which invests in private companies as part of our M&A – and I’d make the case for many of you – it’s also the best of times if you’re prudent, if you understand how value is created, and if you can use capital appropriately in turbulent times.  So this is an important message both inside the company to keep our people’s heads up and also we think outside the company so that all of us as investors in one form or another stay focused on the future. 

UPS has a long history – as a private company for 92 years and as a public company for 10 years now – and we have had a very conservative approach to the balance sheet.  As a private company, we had a huge push where every year we distributed significant amounts of equity to the 35,000 managers in the company.  As a result, we asked our people to have a lot of eggs in their basket of UPS.  We felt it was necessary to have that basket be very strong and safe, so we had a history of prudent capital management and even after going public, we’ve resisted to some extent the urge to lever up too much.  We remain one of about 25 or 26 companies with a AA rating. I was joking at dinner tonight that for the first time in my career, I’ve actually had analysts come to the company and tell us that our AA rating is really the lowest cost to capital. That’s certainly a different story than you heard a few years ago, but the attributes of our business create a financially strong business.  It’s a network business.  Incremental investments create high incremental returns. 

We see strong free cash flow, in the range of $4 billion last year.  Cash flow from operations was $7 billion.  We typically reinvest 5 or 6% of our revenues in capital.  Clearly this year, we’ve tightened up.  We’re basically planning for no growth globally, so any growth projects as far as capacity have been frozen.  Growth projects as far as investments for the future continue.  We do create a fairly strong dividend.  Unfortunately, the yield’s a little higher than we’d like right now due to the low stock price, but we have been dedicated over the last four or five years to distributing over 100% of net income back to shareowners, either in the form of dividends or share repurchases. Last year we did about $3.5 billion because we do generate positive cash flow even in the worst of times.  So it’s a good flexibility to have. 

On the other hand, the top priority for our capital – and I think hopefully there is some resonance here – is to invest in growth opportunities.  It’s just that those growth opportunities have to be prudent and properly priced in order to generate superior returns to investors in the market. We’ve also begun to leverage the balance sheet.  We were AAA a year ago and we decided to leverage a little bit and have created an external measure of funds flow from operations to debt, really to telegraph to the market our constraints that we will operate within these realms, but trying to strike a balance between appropriate leverage, utilization of cash flows and financial discipline.  These are turbulent times – unprecedented.  We’re seeing changes in our normally stable business – the small package pick-up and delivery – that we’ve not seen in decades, not counting the incredible velocity of changes in some of our newer businesses of freight forwarding, brokerage and facilitating global trade.

So these are volatile times and it’s disappointing, frankly, to look at the bottom line every month and see the results that we’re generating, even though by comparison I guess we’re the tallest pygmy or the fastest dog in a slow race, whatever paradigm you want to use. But at the same time, we see tremendous opportunity.  Our relative strength in the industry is the best it’s been in almost my entire 32-year career.  So it’s important for us as fundamental investors to realize that, and I think it’s also a lesson for all of you.  You’ve got to be defensive, but at the same time, if you cover up totally during these periods, you miss some of the best opportunities that may happen. 

So we’re being very prudent, holding ourselves accountable to discipline and metrics.  We are protecting the balance sheet above all else.  As I said, we bought $3.5 billion worth of stock last year.  We think it’s prudent to slow that down, even though we think the stock’s a great bargain. We think the benefits of liquidity and the options of having that balance sheet outweigh that. We continue to enjoy a very low cost to capital.  We just went out with $2 billion of debt week before last at very favorable rates, so that is a true asset that can be used in times that are tough. What we see is this capital capacity gives us a range of options and as we were chatting over dinner, tremendous opportunities on the M&A side as management expectations begin to get down to the realities of today’s market. They’re not quite there yet.  There’s at least a six-month lag between when equity values change and when the management of the targets begin to realize that maybe this is a new normal. But opportunities will come and we think that this will be a very interesting time for those with capital and capacity. 

Frankly, we’re glad we aren’t seeing some of your providers out there as much as we have been.  There’ve been some environments in which the private equity people have been bidding up prices for some of the fundamental companies we’ve been trying to buy, and we’ve had to step aside.  We think as a fundamental or a strategic buyer, this is a great time and for those private equity firms that don’t rely primarily on leverage to create value, it’s also a great time if they understand how value is created. 

But we’re also very internally focused right now.  It’s all hands on deck.  There’s a burning platform and, frankly, this is one of the easiest times to be a CFO, which is hard to believe.  It’s one of the easiest times because there’s a general acknowledgement that things have to change, that radical and painful changes need to be made to defend and protect businesses.  So even though it’s the worst of times in that balance sheets are going up in flames and profits are dropping, it’s the best of times in that these are the times when companies that are well focused get stronger.  It’s hard to do when times are good.  Right sizing and realignment are very difficult when there’s no burning platform.  Today, those arguments are much less painful.  So we’ve been very aggressive in making sure that we both invest for the future but also make the necessary reductions. 

On the positive side, we’re pushing aggressively to invest in operational efficiencies – leveraging technology, creating data-driven operations with automatic route planning and optimization, and using telematics to give us real-time information on our delivery drivers. Plus there’s a big push for alternative fuel vehicles.  We have the largest private fleet in any industry.  We’re not quite there yet from an economic perspective, but we will be ready when the economics do come together and hopefully the government also begins to standardize their incentives so that private corporations can begin to invest towards a common standard. But we’re very aggressive on the compressed natural gas side.  We just added another 300 vehicles in the U.S.  We have a number of hybrid vehicles.  We even have a hydraulic hybrid that’s a fascinating new technology.  We’re going to keep pushing the envelope.  Actually, UPS’s first alternative fuel vehicle was put into operation in 1930 in New York, where we tried a battery-driven vehicle.  A little before our time, but it was a gallant effort, I guess.

So you’ve got to stay at the front edge.  You’ve got to keep understanding where the ball’s going and begin to invest where you see it headed. Those things are important even in the toughest of times.  We’re also, though, aggressively looking to right- size and adapt our business to match the current reality.  Revenues are dropping, and you’ve either got to adapt and drop your cost to match that or suffer significant impact.  So we are on high alert adapting our network on a daily basis.  The paradigm at UPS is you go in and out of business every day.  You plan what you need for that day.  You adjust the hours, you adjust the routes, you re-route volume to get optimal utilization. So it’s a high alert, active management of the business in a way, perhaps, it hasn’t been before. 

We’ve also set up a series of simultaneous initiatives to take costs out. For example, we’re making major changes in our air network.  We have a global footprint between our small package and our freight forwarding, with incredible volatility.  One example – our volumes from Asia, primarily China to Europe, over the last year and half have been growing at a 20% compounded rate.  As Europe continued to buy, they became more comfortable with Asia as a supplier, feeding into our integrated European network.  In the third quarter, that was 20% growth.  In the fourth quarter, that was flat.  Those kinds of changes require absolute active dynamic management of a business or you end up with terrible returns to capital. 

So that’s the kind of high alert companies need to be on.  It’s just a slightly different approach to the business where you go in and out of business every day, every week rather than just kind of doing what you did yesterday. Certainly for those companies that either you oversee actively or passively, that’s the kind of management focus that has to happen today because the world changes on a weekly basis as opposed to multiple months in the past.  So it’s essential that management stay on their toes and have the courage to make organizational changes to do things you knew you needed to do for years but never quite had the impetus to do.

But that’s the positive thing about recessions.  They force good companies to get better, and they weed out the companies that can’t make the turn.  One of the more interesting things and maybe this highlights my four-year detour into sales and marketing, is to make sure that the customer offerings and the portfolio matches the current customer needs.  Service at any price sounds great in a growing environment, but when times get tough and customers need to save money, it’s the ultimate arrogance to offer over-contented products.  A good example of this – I used to sit on Chrysler’s executive supplier council and the marketers and engineers would argue over whether we really need 20 different rearview mirrors in their cars.  You have to value engineer your products, and the equation changes as the economy changes. So it’s a marketing issue to make sure that what you’re offering in the marketplace meets the current needs. There may be an environment in which 20 different rearview mirrors adds value.  I’ll guarantee you right now customers don’t want to pay an extra $100 a mirror to do that, and that’s what you have to trade off. 

I think a well-run company revisits itself and reinvents itself comprehensively across its product line, across its go-to-market strategies, across its operating and across its financial attributes. That’s certainly what we’re trying to do anyway.  At the same time, these are tremendous times to extend competitive advantage.  Companies that have sustainable competitive advantage actually pull ahead of the pack when the hills get steep.  That’s when you really separate from the pack, and we think that’s the same in our industry.  So at the same time we are slashing and burning and cutting expenses, we’re also looking to expand our services in areas that create competitive advantages, and offering broader coverage in some geos that we can do for low cost, like improving time in transit for our UPS freight operation in the U.S. 

We’re also creating new alliances.  UPS and the post office used to be bitter enemies.  Tough times make for strange bedfellows, to twist that line, and we’re now working hand-in-hand with them to help them be a conduit for returns for our B-to-C business. People can receive goods via UPS and return them by sticking them in their mailbox. Then UPS drivers make pick-ups at the post office.  So creative alliances are necessary in today’s environment and can create value. 

We’re also pushing our unique capabilities. We spend over a billion dollars a year in technology to find ways to help companies become more efficient. We’ve introduced breakthrough things like paperless invoice where we’ve negotiated with over 100 customs agencies across the globe and built enough credibility that they’ll accept electronic data to clear packages rather than traditional paper invoices.  That’s been out for a year and a half.  It’s a huge saver, from a sustainability perspective, from an ability to clear packages more quickly, and from a cost perspective.  So the trick is figuring out what really adds value, filtering that out, and continuing to invest while at the same time you’re absolutely ruthless on those things that don’t add value. 

It’s also a great time to expand your global footprint.  Prices are great right now.  It’s a great time to be a buyer if you’ve got the discipline, so we’re continuing to invest to expand some of our capabilities to build this global footprint that can help customers with their supply chains. Worldport is our big domestic air hub.  That’s allowing us to create new operating efficiencies.  China continues to be a growth market, so we’re opening hubs in Shenzhen and Shanghai that will connect to the rest of China with an aggressive intra-Asia network and to the global network. Those are long-term investments. 

There’s also a silver lining to these times if you are a solutions provider.  The same message about burning platforms allowing breakthrough changes inside the company applies to our customers, and Merck is a great example.  Merck is a great company with as great a history as UPS.  They’re also a company that has not relied on outsourcing. But given the way healthcare is trending and the new cost pressure, we were able through a multi-year process to announce a deal with them where they turned over their entire distribution of pharmaceuticals and vaccines to UPS.  We actually manage their warehouses, converted them from single client to multi-client, and leverage our technology to allow them to operate more effectively. 

So the worst of times can create new opportunities for companies.  There are a number of other areas where we’re continuing to invest. We’ve become very aggressive in real estate.  We lease thousands of buildings across the globe.  Every one of those buildings has contracts, typically with automatic lease renewals. Our real estate people tended to just punch their tickets and do automatic renewals if we wanted to stay in that building.  The last three months, we’ve stopped that and said real estate is now a hunter organization rather than a management organization. We’re only approving our lease renewals at no more than the existing lease, so all of our people are asking for renegotiations for any lease renewal, even in a building we know we want to be in. We’ve been amazed at the results.  It’s low-hanging fruit.  One of the lessons is, if you don’t ask, you won’t get. We have also been checking the financial viability of our landlords to see if perhaps a liquidity event would be of interest to them and in many cases able to purchase assets we know we need for the long-term at 50 or 60 cents on the dollar. So there are great opportunities if you know what you need and you have the cash to apply it. 

On the M&A side, we’re as busy as we’ve ever been, assessing what’s going on.  As a strategic buyer, we’ve been in competition with some of your providers when leverage was easily accessible. It was hard for a strategic buyer to compete with somebody who creates value sheerly through financial engineering.  This is a much healthier environment, at least from our perspective, in that we’re competing with companies that are looking for the true inherent value. I think that’s an important message.  Whether you are an internal investor in a corporation or you’re a third party, separating the financial engineering from the true business model value creation is the essence of good investing. If you’re not sure where the value comes from, then there’s a lot of risk. 

So it’s the best of times and the worst of times. How does the CFO fit into this?  I’m fairly new to the job, about a year and a half or so, but I’m starting to figure it out.  One thing, especially for a company that’s been private for many years, is that the CFO in a corporation has a unique position in that they live in the external world as much as the internal world. So the responsibility of a CFO is to bring the external insights into the corporation.  You have to have one foot in Wall Street or at least the external markets and one foot inside the company to create the greatest value. You have to be a catalyst that allows the voice of the market inside a company no matter how great their history, how strong their balance sheet or how storied their management team.  It’s also essential that the CFO play a much stronger role in strategy.  The world is much too complex these days for a CFO to be a glorified bean counter, and if they don’t understand the essence of strategy, if they don’t understand the value creation inherent in the business model and how to extend that, then they’re missing the boat and you’ll make decisions that aren’t financially sound.  At the same time, the bean counter can’t just be a naysayer.  They’ve got to allow the company to fail fast, to try many things and not think you have to have a .1000 batting average.  If you’re batting average is too high, you’re not trying enough things, and that goes against the culture of a lot of finance and accounting groups. But success comes not through a high batting average but through getting up to the plate and having a solid batting average. 

The vision, then, is to grow liberally, but at the same time make sure that the finances are conservatively managed so that the company has reserves.  I guess the best metaphor – just to torture this graphic here, -- the CFO is served best to think of themselves as a gardener, to know when to fertilize and put capital into events, but also have the discipline to prune off those branches that are sapping the energy from the tree. It’s the same thing in private equity investing – to have the ability to put capital out there, but also the discipline to know when not to feed the sick components of the business. So it’s the same inside of corporations as it is outside of corporations, and at least within a corporation the CFO has got to be the point at which that objectivity occurs and it’s not always easy. 

So that’s it.  To brutalize this poor Tale of Two Cities metaphor a little more, I think what we’ll see as this economic cycle stabilizes is a tale of three companies. There will be three different kinds of companies that will emerge from this current economic crisis. Some won’t come out at all or will have retreated substantially -- a good example is DHL here in the U.S., having overextended now pulling back with billions of dollars of losses in our segment because they really went to market with a business model that wasn’t sound.  Many others will come out of this cycle intact but severely weakened, either with their balance sheets brutalized or with their resources reduced so dramatically that they can’t take advantage of growth. And then a few, a select few, will come out both leaner and financially stronger than ever, where their competitive advantage extended beyond what they were before this period. We think that UPS is one of those great companies that has an inherent sound business strategy, that remains focused on growth but also is prudent enough to know when to prune the branches and when to fertilize.  So that’s our story and I’d be glad to take any questions of interest to you. Thanks for the opportunity.