By now, investors who follow UPS (NYSE: UPS) will know that the company delivered a set of second-quarter results on Tuesday that can be best described as “disappointing.” The market certainly felt that way — as of midmorning Wednesday, the stock was down by close to 14% from where it traded before the report came out.
The quarter did feature some positives, including a return to delivery volume growth in the U.S., and the company is set for a stronger second half. Still, the question marks around its management will likely remain until it can report a few quarters of stable earnings. It all makes for a complicated investment proposition.
UPS management’s history of disappointment
Management just backpedaled on its initial full-year guidance for the second year running. I’ll get to this year in a moment, but first, consider what happened in 2023. UPS faced understandable challenges, such as a protracted and contentious contract renegotiation with the union representing 340,000 of its workers. The difficulties management had in coming to an agreement with labor caused some customers to shift their shipping to other networks for fear of strike actions. In addition, UPS experienced deteriorating end-market demand due to relatively high interest rates and slowing economic growth.
Moreover, it’s worth noting that in April — before the labor dispute impacted its earnings — the transportation company already lowered its full-year 2023 revenue and adjusted operating margins guidance to the low end of the initial guidance ranges given in January. Simply put, management overestimated the strength of demand for delivery volume in 2023.
What about 2024?
The following table highlights how management just updated its full-year guidance. It should be reiterated that during its investor day presentation in March, management affirmed its full-year target and gave three-year targets. As you can see below, the July reductions are significant.
They come in the wake of an adjusted operating profit decline of 30.1% in the first half — a figure slightly below the low end of the range given during the investor day presentation, when management forecast a decrease of 20% to 30%.
|
Metric |
2024 Guidance as of January |
2024 Guidance as of April |
2024 Guidance as of July |
|---|---|---|---|
|
Revenue |
$92 billion to $94.5 billion |
$92 billion to $94.5 billion |
$93 billion |
|
Adjusted operating profit margin |
10% to 10.6% |
10% to 10.6% |
9.4% |
|
Implied adjusted operating profit* |
$9.2 billion to $10.02 billion |
$9.2 billion to $10.02 billion |
$8.74 billion |
Data source: UPS presentations. *Calculations by author.
The critical issue in the second quarter wasn’t so much delivery volumes — they shifted to growth in the U.S., as management had said they would — as the 2.6% decline in revenue per piece in its core U.S. domestic package segment.
Meanwhile, in the international segment, it was the opposite story, with a 2.9% decline in volume and a 2.4% increase in revenue per piece.
When all was said and done, international package segment revenue declined 1% in the quarter while U.S. domestic package segment revenue fell 1.9%, leading to an overall decline of 1.1%.
The dynamics of the U.S. domestic package segment are shown in the chart below. In Q2, a slight uptick in volume growth was accompanied by a significant decline in revenue per piece.
Data source: UPS presentations. Chart by author.
What went wrong
Discussing those dynamics on the earnings call, CEO Carol Tome said, “We’ve had these new e-commerce entrants into the United States. And their volume, well, it’s exploded. It was certainly more than we anticipated flowing into our network.”
In other words, a surge in lower-margin volume resulted in a negative mix shift toward cheaper delivery options. That’s concerning for two key reasons.
First, it runs contrary to the company’s “better not bigger” framework, under which UPS aims to focus on its most profitable delivery categories rather than chasing volumes per se. While Tome did say UPS wasn’t “chasing volume” and hadn’t expected the new customers’ volume to explode in the way it did, a few questions spring to mind.
Image source: Getty Images.
Would UPS have reported U.S. delivery volume growth without the growth in low-margin volume? Moreover, CFO Brian Dykes said he expected “the product shift we experienced in the U.S. will continue through the rest of 2024,” and management reduced its full-year margin guidance accordingly, so clearly, UPS is baking these lower-margin deliveries into its guidance.
Second, given the company’s discussion on the issue of excess capacity in the small package market in the U.S. during its analyst day presentation, it’s hard not to think that pressure on revenue per piece is a consequence of oversupply, and could continue through the rest of 2024.
Is UPS stock a buy?
After overestimating what its delivery volumes would be in 2023, management has disappointed with guidance again in 2024, and arguably only improved its U.S. delivery volume through the addition of less profitable deliveries. Whichever way you look at it, this was a disappointing earnings report.
Image source: Getty Images.
Still, one can put a positive perspective on this week’s events. For the market, it’s an opportunity to reset its expectations; for individual investors, the sell-off can be considered a buying opportunity. The updated implied earnings guidance has UPS trading at just 12.5 times its adjusted operating earnings at its current stock price. However, UPS will need to report at least a few quarters of solid results to fully regain investors’ confidence.
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Lee Samaha has no position in any of the stocks mentioned. The Motley Fool recommends United Parcel Service. The Motley Fool has a disclosure policy.
