2023-10-10 05:26:52 ET
Summary
- UPS stock has been negatively impacted by stiff competition, weakening consumer demand, high fuel prices, and the overall market correction.
- Despite these challenges, the economy remains strong and the consumer is still a strong spender, especially during the upcoming holiday shipping season.
- Investors and traders may find opportunities in UPS stock, with potential target entry points and a positive outlook for earnings growth in the future.
- Nice dividend growth and a high-yield while you wait.
We are sure you have heard of the expression of "throwing in the kitchen sink" in terms of an onslaught of bad news. Well, all one has to do is pull the recent chart for United Parcel Service (UPS) stock and you will see shares down as a result of a litany of bad news. From stiff competition, to a potentially weakening consumer, to high fuel prices, this transport/ good shipper has been crushed. The market as a whole has experienced a significant correction, adding fuel to the fire. But the economy, while showing some signs of cooling a bit, is still strong. The consumer, while starting to fatigue with high interest rates for consumer debt, coupled with the return of student loan payments, remains a strong spender. This all comes as we approach the busy holiday shipping season, a critical time for this important quarter. With the dividend being consistently raised, we think investors will enjoy a strong total return by getting in on this correction. Moreover, for traders, we also see opportunity.
As you can see from the chart, we have round tripped from late 2020 levels, three years of gains wiped out. UPS stock peaked with the S&P 500 ( SP500 ) in January 2022. The correction in markets began, and with it, UPS shares have fallen along with it. We saw a nice run for the market in 2023, and UPS moved from about $170 to nearly $200, only to fall again, and to finally sell off with the latest correction from late July. While the company faces headwinds, we think investors and traders will be rewarded by starting to buy in here. For traders, which we largely cater to in our group, here is a play to consider
The play
Target entry 1: $153.50-$154.50 (30% of position)
Target entry 2: $149.70-$150.25 (33% of position)
Target entry 3: $145.25-$145.50 (37% of position)
Stop loss: $138
Target exit: $170 if one leg, $165 if two, $160 if three
Options considerations: There are a number of premium selling approaches as well as call options to consider but specific options trades are reserved for ideas for our members. The above trade is an example are of the trades we do there.
Discussion
When the name recently reported its earnings , we saw a company obviously feeling the pinch. Lower revenues, lower margins, and lower earnings from a year ago. Thus, much of the price action we have seen has been justified, but we think that earnings have troughed. Based on what we are seeing here, the name is in an attractive target area in the $145-$155 level. Short-term traders who enter here may wish to consider a stop-loss order as prescribed above, and long-term investors should enjoy a price that appreciates back over $200 in a number of quarters along with a solid dividend along the way.
While Q3 won't be reported until later this month, the Q2 report gave a strong indication for where things are going. Moreover, we are now just about to enter the very seasonally important period of the holiday. Fuel prices have been a drag, and you can see a negative correlation with share prices relative to energy prices. While that headwind will persist, there are reasons to be positive, despite performance that has fallen from last year.
In the most recent quarter, revenue came in at $22.1 billion. Revenue was down 10.9% year-over-year and a big miss of $1.07 billion versus total consensus. Revenue was down in all segments. In the Domestic Package segment, revenue decreased 6.9%, driven by a 9.9% decrease in average daily volume, which was partially offset by a 3.3% increase in revenue per piece. In the International Package segment, Asia weighed. Revenue declined 13.0%, due to a 6.6% reduction in volume. In the Supply Chain Solution segment, revenue fell 23.4% due to lower market rates and volume decline, but there was positive growth in logistics that is noteworthy.
Like any other company offering a service, to increase revenue, the company can adjust its pricing over and over. However, keep in mind that there is a limit to this given competition. If pricing gets too out of line on the high side, then many large customers will opt for another shipper. But, pricing power has offset a lot of volume declines. But why are volumes down? Volume is really the name of the game here. The company (and its competitors) engage in an ongoing, multi-factor balancing act to maximize volumes with attractive pricing that keeps margins strong. Generally, the company has outperformed, but lately, volume has been hit. This quarter was a touch slower than consensus expectations. What is interesting is that volume declines were across both the residential and commercial categories. Some of the issues are inflation reducing orders, declining manufacturing activity, which use UPS and their competitors to move goods, as well as aforementioned slight reductions in consumer spending. Further, there was an ongoing contract debate with the Teamsters union. That has since been resolved, but is on the order of $2.2 billion in costs going forward as the Teamsters sought better rates.
In terms of earnings, yes, revenues were down, and operating expenses, while a focus of the company, did not decline enough to preserve UPS' usual margin power. Margins fell, and so did earnings. Net income fell from $2.85 billion a year ago to $2.08 billion. On a per share basis, earnings fell from $3.25 to $2.42. Given this performance, and costs with the union contract with the Teamsters, the so-called "kitchen-sink" was thrown in. Management had to cut expectations for the year. But we see this as a trough. Although management does not guide for revenue or earnings, we can hone in on it given the volume declines and higher pricing, and the trajectory of shipments. Management down guided its adjusted operating margin to 11.8% from 12.8% from the prior view. This will result in adjusted operating profits declining to just under $11.0 billion versus $12.42 billion previously seen. We believe that Q4 will enjoy a strong shipping season, and pull up some of the rear. For the year, we see revenues of $92.0-$93.0 billion, down about 8% from a year ago, while EPS will likely come in at $8.75-$9.50, which will be nearly a 30% decline from a year ago. That is painful, but driven in part by H1 2023 results. However, we see EPS ramping back up in 2024 and beyond from these levels, which is why we think it is time to start buying. Further, the dividend continues to grow:
This is the kind of stock you want to own in a market that is a bit chaotic. A dividend growth company. While yes, right now, you can do better by sitting in cash or bonds for simple income, you do not get the future increases or capital appreciation. We like the 4% yield here.
From a valuation standpoint, we like what we are seeing here at $154 per share. With our consensus view, we are trading at 16X FWD EPS, which is fair. The EV/EBITDA is around 10X, while on a price to cash flow basis, we are at 11X. We view this as attractive for an investment. For traders, the chart is basing, the stock is valued attractively, and the market is also entering a seasonally strong period. Oh, and keep in mind not only is the company paying about $5.4 billion in dividends, it is also pushing for $3 billion in share repurchases, further boosting future shareholder value.
Take home
The chart suggests a bounce, and earnings growth looks like it will be solid after this fiscal year. While competitor FedEx (FDX) has been in command in terms of stock performance lately, and is also valued attractively, UPS stock in our opinion offers snapback potential. We like to see gains like that and are happy to collect the dividend in the meantime.
For further details see:
UPS: After 'Kitchen-Sinked' With Headwinds, Shares Are Now A Buy