2023-10-26 16:07:32 ET
Summary
- UPS shares dropped 5.4% after missing revenue and earnings expectations for Q3 2023.
- Weakness in revenue and operating profit guidance for 2023 as a whole proved to dash investor sentiment and understandably so.
- Labor disruptions and contract negotiations caused a decrease in volume and revenue for UPS, but even without these, there's a better prospect to consider.
Oct. 26 wasn't exactly the best day for shareholders of United Parcel Service ( UPS ), more commonly known by the name UPS. Shares of the company declined, dropping approximately 5.4%, after news broke that management missed revenue and earnings expectations for the third quarter of its 2023 fiscal year. They did manage to exceed expectations when it came to adjusted earnings. But outside of that, the company posted quite a bit of weakness. For instance, revenue and operating profit guidance for 2023 in its entirety also has been reduced.
Unfortunately, this is not the first time that the company has declined in price recently. Back in August of this year, I wrote an article about the firm wherein I rated it a "hold" based on how pricey shares were compared to rival FedEx ( FDX ). Although I believe that UPS will be fine in the long run, financial pain this year led me to downgrade the company from a "buy" in that prior article. That pain has actually been worse than I anticipated. This is evidenced by the fact that, since the publication of that article, the stock is down 20.8% while the S&P 500 has dropped only 7.7%. I wouldn't say that the picture is bad enough to warrant yet another downgrade. But I do think that investors should tread cautiously in the near term.
A difficult quarter
By pretty much every measure you can imagine, the third quarter of the 2023 fiscal year was not kind for UPS and its investors. It might be best to start with revenue. During the quarter, sales came in at $21.06 billion. That's 12.8% lower than the $24.16 billion generated the same time last year and it happened to be $410 million lower than analysts anticipated . The firm experienced weakness across the board. But its greatest weakness came from its smallest segment known as Supply Chain Solutions. This is the part of the company that involves its forwarding, truckload brokerage, logistics and distribution, and other miscellaneous operations. Revenue for the quarter came in at only $3.13 billion. That's 21.4% lower than the $3.99 billion generated one year earlier. Management attributed this pain to a weak global economy, with international air freight volume plunging. Truckload brokerage unit volume also faced market pressure, though there was strength in ocean freight thanks to attractive demand from the retail sector.
The company’s other segments experienced downside as well. Both the US Domestic Package and International Package segments reported revenue declines of 11.1% year over year. On the domestic front, most of the pain came under the Ground operations of the company, with the average daily volume of goods transported plunging 10.7%, or 1.74 million. Interestingly, most of this pain can actually be chalked up to what should now be considered a one-time event as opposed to a general softening in the market. Management estimated that, during the quarter, there was about a 1.5 million package per day volume diversion caused by union contract negotiations.
What this means is that, because of labor disruptions and the perception of disruptions, more UPS shippers decided to transport their goods by other means. That means with other shippers. This was largely expected by market participants. Back in August, for instance, the company made clear that it was preparing to win back volume that it lost during the fracas that it had with the Teamsters Union. And by late September, there also were reports that the company had hoped to win back most, if not all, of diverted volumes seen in that quarter by the end of this year and that it was willing to offer rebates to get there. That doesn't change the fact that a decrease in volume cost that segment $2 billion in revenue during the quarter compared to the same time last year. By comparison, an increase in average revenue per piece helped offset this by only $271 million. International volumes also we're down. Domestic average daily volume dropped 9.1% year over year while export average daily volume dropped 4.1%. But given the key driver behind its domestic operations, this is not a surprise.
As revenue dropped, profits took a beating as well. Earnings per share came in at $1.31. That's dwarfed by the $2.96 reported one year earlier. Earnings also were worse than what analysts forecasted. Analysts had actually forecasted earnings per share of $1.59. On an adjusted basis, the picture was a little better. While adjusted earnings plunged from $2.99 last year to $1.57 this year, the adjusted figures reported were actually $0.01 per share higher than what analysts thought they would be. This translated to a drop in adjusted profits from $2.61 billion to $1.35 billion, while GAAP profits fell from $2.58 billion to $1.13 billion. Other profitability metrics came in surprisingly strong. Even though operating cash flow fell from $2.48 billion last year to $2.23 billion this year, adjusted operating cash flow, which ignores changes in working capital, rose from $1.98 billion to $2.48 billion. Over that same window of time, EBITDA for the company improved from $2.21 billion to $2.41 billion.
As you can see in the chart above, the weak performance in the third quarter has been part of a larger trend for the company. Results for the first nine months of this year as a whole were materially worse than they were the same time last year. This has, unfortunately, resulted in an overall decline in guidance for the year as a whole. When management announced financial results for the second quarter, they anticipated revenue for 2023 of $93 billion. That number is now forecasted to come in at between $91.3 billion and $92.3 billion. The company also is forecasting a decline in its operating profit margin that should bring operating income down from a prior expected level of $10.74 billion to only $10.14 billion. This has had a cascading effect, translating to the company's decision to scale back share repurchases. Prior guidance had called for share buybacks to total $3 billion. That number has now been reduced to $2.25 billion.
If we take management's guidance as accurate, then net income this year will probably come in at around $7.73 billion. That would represent a sizable decline from the $11.55 billion generated in 2022. Based on my own estimates, adjusted operating cash flow should fall from $16.28 billion last year to $11.95 billion this year, while EBITDA should come in somewhere around $11.39 billion vs. the $14.47 billion reported for 2022. Using these numbers, I then decided to value the company as shown in the chart below.
As you can see, the stock does get more expensive when looking at it on a forward basis. We do have to give the company some credit because of the one-time impact caused from by union issues. But this doesn't change the fact that I do like its rival, FedEx, more. In the table below, you can see how the two companies are priced against one another. Even if UPS were to see its financial performance revert back to what it was in 2022, FedEx would be cheaper than it using two of the three profitability metrics included in said table.
Company | Price / Earnings | Price / Operating Cash Flow | EV / EBITDA |
UPS | 15.5 | 10.0 | 11.7 |
FedEx | 13.9 | 6.1 | 6.8 |
Takeaway
Operationally speaking, the most recent quarter was not pleasant for UPS or its investors. Long term, I still suspect that the company will do just fine. But this doesn't mean that it's a great prospect to buy into right now. Although I have no doubt about the long-term outlook of the company, FedEx is more attractive to me at the moment and, since I last wrote about it in June of this year, shares have outperformed the market, dropping 2.1% while the S&P 500 has declined by 5.7%. For those who want a stronger operator in this space, it might be the better prospect to consider.
For further details see:
UPS Takes A Well-Deserved Dip After A Painful Quarter