2023-09-06 16:00:00 ET
Summary
- My Sell rating on United Parcel Service stock last year panned out accordingly. However, I assessed that the worst decline experienced by UPS holders is likely over.
- UPS saw selling pressure intensifying over the past month, hampered by uncertain macroeconomic conditions and its recently concluded labor negotiations.
- Despite that, UPS should see its revenue and earnings improve further as the global economy is not expected to fall into a deep recession.
- While UPS' valuation isn't cheap, its robust profitability and wide economic moat justify a premium valuation.
- I argue why UPS buyers should capitalize on the recent steep plunge to add more shares before the dark cloud clears. Upgrade to Buy.
I last updated United Parcel Service ( UPS ) investors in July 2022, as I cautioned that UPS struggled to regain upward momentum, suggesting significant caution. As such, I assigned UPS a Sell rating to reflect what I believe are substantial challenges for the stock.
The Sell rating panned out accordingly, as UPS fell toward its October 2022 lows before bottoming out. However, the recovery has taken a turn for the worse over the past year, hobbled by uncertain global macroeconomic conditions and the recent labor negotiations.
As such, I'm not surprised that UPS has significantly underperformed the S&P 500 (SP500) since my previous update. That said, I believe we have an opportunity to turn more constructive on UPS despite the recent pessimism, as I think the worst in its operating performance is likely behind us. Let's see.
United Parcel Service's second-quarter or FQ2 earnings release in early August led to a sharp decline in its stock, as market operators priced in significant headwinds on its ability to recover lost volumes amid its recently concluded labor negotiations.
However, the wide economic moat company remains solidly profitable, even as it reported a consolidated adjusted operating margin of 13.2% in FQ2 (Vs. Q1's 11.1%). However, I believe market operators are pricing in near-term cost challenges on the company's earnings growth recovery, which remains impacted by the pandemic surpluses that continue to normalize. Accordingly, United Parcel Service saw a steep 18.4% YoY decline in its consolidated adjusted operating profit. Management's commentary indicates that tepid performance was observed globally, particularly in the U.S., the company's primary revenue driver.
Despite that, I believe we have sufficient reasons to be more optimistic from here. Management highlighted that the rate of volume decline was less pronounced in July than what it experienced in June. As such, we should observe improvements from Q3, although the recovery is not expected to be rapid. That seems reasonable to me, as interest rates are still high globally. Moreover, macroeconomic conditions remain uncertain, impeding a sharp near-term growth inflection.
Notwithstanding the caution, investors need to remember that the market is forward-looking. By the time you wait for the dark clouds to clear, UPS would likely have already recovered. Hence, assessing whether you believe the global economy could slide into a hard landing or maintain the soft landing approach is opportune. The consensus view among economists has improved over the past year, as they no longer see a debilitating recession. It's a notable improvement from last year's peak pessimism, which even saw Bloomberg Economics telegraphing a " 100% recession call over the next twelve months" in October 2022, possibly scaring some weak holders into submission.
Despite that, astute UPS investors saw the massive capitulation in investors' sentiments, proffering a golden opportunity to pick up the pieces in UPS over the past year. The good news is that UPS' October 2022 lows remain well-supported and not expected to be decisively breached, given my expectations that the worst is likely over.
UPS price chart (weekly) (TradingView)
As seen above, UPS buyers defended its October 2022 lows with high conviction, underpinning the lows it formed in August 2020. As such, it's a highly significant support zone that buyers have held for more than three years (and counting).
I assessed that unless things take a significant turn for the worse (for instance, an unanticipated hard landing), we would not likely revisit those levels.
As such, I expect buyers to hold the May 2023 support levels robustly, as observed over the past two weeks. However, I have not gleaned any decisive price action that suggests a validated bullish reversal is in place.
Despite that, while UPS' valuation seems well-balanced (Seeking Alpha Quant valuation grade of "C+"), more constructive price action could follow.
Hence, I assessed that as the market priced in the recent headwinds as seen in its price action, United Parcel Service, Inc. looks well-primed to stage a second-half recovery before the dark clouds clear. By the time they clear and things look pristine, we could find UPS trading at higher valuation multiples.
Rating: Upgraded to Buy. Please note that a Buy rating is equivalent to a Bullish or Market Outperform rating.
Important note: Investors are reminded to do their due diligence and not rely on the information provided as financial advice. Please always apply independent thinking and note that the rating is not intended to time a specific entry/exit at the point of writing unless otherwise specified.
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United Parcel Service: Steep Plunge Unleashes Its Bullish Turnaround Story (Rating Upgrade)