2023-04-26 07:30:00 ET
Summary
- United Parcel Service's first-quarter earnings and revenue fell short of expectations.
- Revenue forecasts for 2023 were also expected to be near the bottom of the previous range. This was a bad outcome for shareholders, who saw their stock fall by 10%.
- UPS is seeing headwinds from low packaging volumes due to lower retail spending in the United States and Asia.
- On the good side, dividend payments are expected to continue to rise and UPS will repurchase $3 billion worth of shares in 2023.
- For the long term, I am confident in UPS as a valuable investment because it has strong growth pillars such as the Digital Access Program, Deal Manager and growth in complex healthcare logistics.
Introduction
On March 5, I wrote my article on United Parcel Service ( UPS ), in which I indicated that UPS is buyable because of its good growth prospects, shareholder return program and undervaluation.
Currently, analysts have become pessimistic for the near future, yet the stock rose 5.4% since the publication of my article to Q1 quarterly earnings.
UPS's Q1 2023 earnings missed estimates, sending the stock as much as 10% into the red. UPS has been plagued by lower package volumes in the United States and Asia due to lagging retail spending. Projections for 2023 have been revised downward. UPS faces short-term difficulties, but in the long term, the low share price offers an attractive entry point. In the long term, the digital access program, growth in SMBs, and complex healthcare solutions are strong growth catalysts.
United Parcel Service's Q1 Earnings Came In Weak
UPS's profit for the first quarter of 2023 came in at a modest $22.9 billion (down 6.1% year-over-year), $80 million lower than estimates. Operating income fell sharply by 22.8% and operating margin came in at 11.1% (down 2.5%). As a result, earnings per share fell to $2.20 (-27.9%), missing estimates by $0.01. This is the first miss in years, and the stock was punished harshly with a drop of more than 10%.
The mediocre numbers were mainly related to lower packaging volumes, which at 1.41 billion came in lower than the expected 1.42 billion. Volumes were strong in the first two months of this year, but fell significantly in March due to shrinking retail sales and changed consumer spending. Exports from Asia remained weak, causing results to lag sharply.
UPS' 2023 Full-year outlook (Q122 Investor Presentation)
UPS expects volumes to remain under pressure for the foreseeable future. With that, it lowered its 2023 revenue forecast to about $97 billion (down 3% year-on-year), and adjusted operating margin is expected to fall to 12.8%. Financially, UPS remains strong with an adjusted total debt to adjusted EBITDA ratio of 1.65.
Looking forward, I see strong growth engines. Digital Access Program (DAP) is one of UPS's strong growth pillars, 16 countries produce DAP revenues and revenues increased 52% compared to the same quarter last year. UPS is well on its way to generating $3 billion in DAP revenue this year.
Another success is Deal Manager, which digitized dynamic pricing for SMB customers. SMBs represent 29.6% of total volumes in the United States, up 1.6% from last quarter.
Another growth driver is becoming the world's number one in complex healthcare logistics. Healthcare logistics is a complex logistics solution because packages must be handled with care due to temperature sensitivity. In the first quarter, its healthcare portfolio grew strongly to $2.4 billion and expects to generate more than $10 billion by 2023.
For the long term, I am confident in UPS because of its good management with Carol Tomé as CEO. She has been at the helm of UPS since 2020 and is the previous CEO of Home Depot. Home Depot has experienced strong growth with her as CEO. Home Depot writes the following about her departure:
"Carol is not only one of the most respected executives in corporate America and an outstanding Chief Financial Officer, but also is beloved by The Home Depot associates," said Craig Menear, chairman, CEO and president. "Since Carol was named our CFO in May 2001 we have delivered more than a 450% increase in value to our shareholders, due in part to her many contributions. We are truly grateful to Carol for her service, and I am deeply appreciative of her partnership over the past five years."
UPS faces several challenges this year but its growth prospects remain solid. From a broader perspective, I expect UPS to weather these challenges and continue to grow.
UPS Dividends and Share Repurchases
In the first quarter of 2023, UPS returned more cash to shareholders than it generated in free cash flow. For 2023, UPS will pay dividends of about $5.4 billion, and in addition it will repurchase shares worth about $3 billion. As a result, the forward buyback yield is 1.8%. The shareholder return program will distribute almost the entire FCF to shareholders.
UPS' cash flow highlights (Annual reports and analyst' calculations)
EPS Downgraded But UPS Stock Valuation Remains Attractive
Analysts have become more pessimistic about earnings estimates for the next few years. In the table below, I have plotted the earnings estimates with their growth and forward PE ratio for UPS and FedEx. In red I color a decline in earnings per share, and the green color indicates an increase. We can see that FedEx has a more attractive PE ratio and is expected to grow at a faster rate than UPS. However, every logistics firm faces its own unique set of challenges and opportunities. UPS has a higher PE ratio than FedEx, but it's still cheaper than its historical average by about 35%. Therefore, at its current price, UPS is grossly undervalued.
Forward valuation and growth for UPS and FedEx (Analyst' own calculations)
Conclusion
UPS's first-quarter earnings and revenue fell short of expectations. Revenue forecasts for 2023 were also expected to be near the bottom of the previous range. This was a bad outcome for shareholders, who saw their stock fall by 10% as a result.
UPS is seeing headwinds from low packaging volumes due to lower retail spending in the United States and Asia. These volumes were good during the first two months, but last month volumes dropped significantly. This put pressure on margins, and for 2023 the company expects sales to decline 3% year over year. On the good side, dividend payments are expected to continue to rise and UPS will repurchase $3 billion worth of shares in 2023. Almost all free cash flow will flow back to shareholders as a result. For the long term, I am confident in UPS as a valuable investment because it has strong growth pillars such as the Digital Access Program, Deal Manager and growth in complex healthcare logistics.
When comparing the current PE to the historical PE, we see that the stock is undervalued by about 35%, which is a positive sign. Despite lower earnings estimates, earnings per share are expected to increase in the coming years and the forward PE ratio is still very attractive. UPS is facing temporary headwinds but the company's strong growth pillars will ensure future expansion. This stock is attractive for long-term investment due to its strong shareholder-friendly management and its attractive stock valuation.
For further details see:
United Parcel Service: Weak Results But A Buy For The Long Term