It's shaping up to be a challenging year for package delivery giant United Parcel Service (UPS 0.14%). A slowing economy and protracted labor negotiations pressured its top-line and margin performance. To add to the challenges, the situation looks like it could get worse before it gets better.
But there's still a strong case for buying UPS stock now and riding out the volatility.
UPS has been hit and miss in 2023
Would it surprise you to learn that UPS both hit and missed its 2023 targets? The company hit the 2023 targets that management laid out in a UPS investor day presentation in 2021 a year early in 2022. However, due to a challenging year, it will miss those same targets in the full year 2023.
The table below illustrates what happened. UPS appears to be making one step forward and two steps back.
|
UPS Metric |
2023 Target at Investor Day 2021 |
2022 Actual |
2023 Guidance |
|---|---|---|---|
|
Revenue |
$98 billion to $102 billion |
$100.3 billion |
$93 billion |
|
Adjusted operating profit |
$12.4 billion to $14 billion |
$13.85 billion |
$11 billion |
|
Adjusted operating profit margin |
12.7% to 13.7% |
13.8% |
11.8% |
Data source: UPS presentations.
What went wrong for UPS
Daily package volumes declined more than expected in its U.S. and international segments due to a slowdown in the global economy. This led to a revenue decline so far in 2023, and there's also a negative margin impact because its higher-priced next-day air and deferred delivery volumes are falling more than its ground deliveries in the U.S. Similarly, in the international segment, its higher-priced export deliveries are falling more than its domestic deliveries.
To be clear, UPS is relatively comfortable with declining volumes. A willingness to forgo less profitable deliveries is a key part of the company's "better not bigger" framework. Indeed, as illustrated below, volumes declined in 2022. Still, the difference this year is that the magnitude of the decline is so large that even ongoing increases in revenue per piece couldn't generate revenue growth for the company. It's a similar story with the international segment.
Data source: UPS presentations. Year-over-year growth.
Underlying improvements are coming
Unfortunately, there's little UPS can do about a slowing economy, but it can continue the operational improvements that led to it meeting its 2023 targets in 2022. This includes the focus on improving revenue quality, and as the chart outlines above, UPS continues to raise its average revenue per piece in the U.S. domestic package segment.
Moreover, back in the investor day presentation in 2021, management outlined four "wildly important" customer-led initiatives to focus on:
- Small and medium-sized businesses (SMBs)
- Healthcare
- International
- Brand relevance
There's evidence to suggest UPS is well on track with these initiatives. For example, management set a target for $10 billion in healthcare revenue in 2023, and it recently confirmed it's on track to hit that target.
Image source: Getty Images.
The SMB initiatives include its highly successful digital access program (DAP). The program offers SMB customers a suite of solutions that help with order management fulfillment to level the playing field with large e-commerce operations. According to CEO Carol Tomé on the second-quarter earnings call, "In the first six months of this year, DAP generated more than $1.4 billion in revenue, putting us on our way to achieving our 2023 DAP revenue targets of around $3 billion."
The highly successful DAP initiative has been expanded internationally, and at least 16 countries are now generating DAP-related revenue. In addition, UPS continues investing in productivity-enhancing smart package facilities and now has more than 57% of its U.S. volume going through automated hubs.
What's next for UPS?
With interest rates remaining relatively high and the global economy continuing to face challenges exacerbated by the war in Europe and rising geopolitical tensions, UPS' volume challenges will likely continue through 2023. As such, don't be surprised if there's further pressure on UPS earnings this year.
That said, it's important to keep a long-term perspective here. Management is doing all the right things in its targeted markets and growth initiatives, and UPS will be in a stronger position to benefit when the economy eventually recovers. Meanwhile, investors can earn a 4% dividend yield while they wait for better days. It remains an attractive stock for investors who can tolerate some potential volatility.
