2023-08-09 09:10:23 ET
Summary
- United Parcel Service reported Q2 financial results, missing revenue and profit forecasts and lowering its revenue and profit outlook for the year.
- The decline in revenue was driven by a drop in package volume in both the US and international markets, as well as weakness in its smallest segment.
- UPS stock also looks closer to being fairly valued, leading to a downgrade from a 'buy' to a 'hold' recommendation.
The market does not always react the way that one might anticipate. Sometimes, positive results relative to expectations can result in upside, while in other cases it can lead to downside. The exact same thing can be said of negative results. A great example of this can be seen by looking at delivery giant United Parcel Service ( UPS ), which reported financial results covering the second quarter of the 2023 fiscal year on August 8. Shares of the company closed down only 0.9% after not only missing forecasts when it came to revenue and profits, but also following a rather painful downward revision for revenue and profits for this year as a whole. In the long run, I still maintain that the company is a solid operator that should do well financially. But between these changes and the fact that shares have risen nicely over the past several months, I do believe that a downgrade from a ‘buy’ to a ‘hold’ is appropriate at this time.
Picking apart results
Before the market opened on August 8, the management team at United Parcel Service announced financial results covering the second quarter of the company's 2023 fiscal year. For the quarter , the company reported revenue of $22.06 billion. In addition to representing a decline of 10.9% compared to the $24.77 billion in sales the company reported one year earlier, it also managed to miss the expectations set by analysts by $1.02 billion. This is quite a sizable decline year over year and quite a large miss in the grand scheme of things. Clearly, something went wrong.
The biggest chunk of this decline came from the U.S. Domestic Package segment of the company. Revenue there dropped $1.06 billion from $15.46 billion to $14.40 billion. This was in spite of the fact that total average revenue per piece (with the company calls a package that is delivered) rose from $12.27 to $12.68. The drop, then, was driven entirely by a reduction in daily package volume. In fact, the decline on this front was 9.9%, with the total number of packages plummeting from 19.69 million to 17.74 million. The biggest drop there involved the Deferred category of services, a decline totaling 22.4%. It's interesting to note that these declines were across both the residential and commercial categories, with issues like inflation, declining manufacturing here in the US, and reductions in consumer spending, all negatively affecting volumes shipped. Management also chalked up some of the drop, though it's unclear how much, to uncertainty regarding the labor negotiations that the company was going through with the Teamsters union.
The U.S. market was not the only area of weakness for the enterprise. Revenue dropped $658 million, or 13%, under the International Package segment. In addition to seeing a 6.6% decline in average daily package volume, the company also reported a drop in total average revenue per piece from $22.17 to $20.91. The same economic factors that affected the US market also affected its operations abroad. Most notably, the company said that there was weakness in the retail and technology sectors that hit it. Although the good news on the rate side of things is that much of that weakness stemmed from lower surcharges when it came to fuel and certain demand related activities.
On a percentage basis, the segment of the company saw the most pain was Supply Chain Solutions. Sales under that segment plummeted 23.4%. Weak customer demand, especially when it came to the export lanes associated with Asia, were instrumental in causing a $365 million decline in international air freight revenue. Part of this pain also came from a reduction in rates that the company charges under this segment because, even as demand has weakened, capacity continues to be built. Truckload brokerage revenue dropped an even larger $372 million because of lower volume and lower market rates. The rest of the drop, totaling $253 million in all, was driven by lower ocean freight forwarding revenue that was caused by lower market rates and volume reductions. Again, much of this centered around the Asian markets, with management particularly focused on the Asia to US lane as higher product inventory levels, lower demand, and additional capacity for shipments, all negatively affected the picture.
On the bottom line, the company also suffered. Net income declined from $2.85 billion to $2.08 billion. This translates to a decline in per share profits from $3.25 to $2.42. This was $0.24 per share lower than the $2.66 that analysts anticipated. Again, much of this can be chalked up to the drop in revenue. Other profitability metrics sadly followed the same trajectory. Operating cash flow fell from $3.81 billion to $3.24 billion. If we adjust for changes in working capital, the decline would be from $4.18 billion to $3.30 billion. And finally, EBITDA for the company declined from $4.02 billion to $3.61 billion. For context, I also, in the chart below, provided financial performance for the first half of 2023 compared to the same time last year. The overall trend for the first half of the year in its entirety is identical to what it was for the second quarter on its own.
When it comes to the future, management also hit investors with some bad news. Union issues, combined with the aforementioned market issues, caused management to decrease revenue guidance for 2023. Prior guidance was for sales to total $97 billion. That has now been reduced to $93 billion. Management does not provide guidance when it comes to net profits or cash flows. The closest thing they provide is guidance when it comes to the adjusted operating profit margin. That number is now expected to come in at 11.8%. That's down from the 12.8% previously anticipated. Even though a 1% decline may not sound all that material, that, combined with the reduction in sales, would result in adjusted operating profits coming in at $10.97 billion compared to the $12.42 billion that management’s guidance previously estimated.
A tremendous amount of uncertainty centered around the agreement that has been all but approved between United Parcel Service and the Teamsters union that represents roughly 300,000 of the company's employees. When the agreement was initially agreed upon in principle, the union estimated that it would result in around $30 billion of value for employees over the five-year term of the contract. We still don't have a full estimate as to what this will be. But we do have a hint based on the financial data provided by the logistics behemoth. For the first half of this year, the management team at United Parcel Service recorded a 5.1% year over year increase in the total cost per piece transported. Management now anticipates that, using an effective date of August 1, the cost per piece growth rate in the second half of this year will be consistent with what it was in the first half. Even though this seems unlikely, management said that much of the costs will be compensated for by the fact that they anticipate increases in average daily volume, as well as improvements when it comes to the company’s network and as the firm benefits from productivity initiatives. Lower anticipated fuel costs should also help the enterprise. It is worth noting that the changes the company is experiencing did not stop management from reiterating their prior target of $3 billion worth of share buybacks and $5.4 billion of dividends this year.
Using the adjusted operating profit margin in relation to the other profitability metrics as an estimate for these other profitability metrics, we would anticipate net profits this year of $9.15 billion. Adjusted operating cash flow would come out to roughly $11.46 billion, while EBITDA would be somewhere around $12.90 billion. Using these figures, we can value the company as shown in the chart above. Clearly, the stock does get more expensive going from 2022 data to 2023 data because of lower revenue and slimmer profit margins. But it should still generate significant levels of profitability. This is not to say that the company is a bargain. It is a high-quality operator and it is trading at a price that is not unreasonable. But as you can see in the table below, shares of rival FedEx ( FDX ) look far more compelling.
Company | Price / Earnings | Price / Operating Cash Flow | EV / EBITDA |
United Parcel Service | 17.1 | 13.7 | 13.1 |
FedEx | 16.7 | 5.5 | 8.4 |
Takeaway
All things considered, there was a great deal of pain that United Parcel Service experienced during the quarter. I am a bit surprised that shares did not fall further than this. However, I do think that the future for the company should be quite appealing. This does not mean that I think that shares make for an attractive opportunity now. Since I last rated the company a ‘buy’ in October of last year, shares have jumped 15.6%. Given that upside, combined with how the stock is priced both on an absolute basis and relative to similar firms, I do think downgrading the company from a ‘buy’ to a ‘hold’ is logical at this time.
For further details see:
United Parcel Service: Worthy Of A Downgrade After Painful Misses