UPS Inc. appeared to be playing all the right notes with its second-quarter results that were disclosed Tuesday morning. But Wall Street heard a flat chord somewhere and knocked its shares down sharply during the trading session.
That chord may have been UPS’ projections of low single-digit average daily volume growth for its core U.S. package business during the current quarter, which began July 1. The guidance could have been expected given UPS’ reputation for conservatism and the difficult comparisons with the barn-burner second half of 2020 and a strong first half of 2021. Yet traders and investors may have extrapolated the guidance as a step toward reduced margins, especially with cost pressures from higher labor expenses and the build-out of nationwide Saturday ground delivery service confronting the company this quarter.
Amit Mehrotra, lead transport analyst at Deutsche Bank, said in a research note that the market was concerned that UPS (NYSE: UPS) guided to lower incremental profit growth along with reduced revenue expectations. The company’s revenue outlook may indeed result in a “meaningful deceleration in growth” even with the difficult year-over-year comparisons, Mehrotra said.
However, the guidance could easily reflect UPS’ cautious nature, and it underscores that the company is rightly more focused on revenue quality rather than volumes, he added. Pricing trends, which are largely within UPS’ control, are headed in the right direction, Mehrotra said, especially with UPS’ revenue mix comprising a larger share of less price-sensitive small to midsize customers.
Mehrotra called Tuesday’s sell-off “overdone” and maintained the firm’s 12-month target of $237 a share.
Todd C. Fowler, analyst at KeyBanc Capital Markets, said UPS domestic margin outlook is “more measured” due to cost inflation and changes in seasonal mix. Yet the “muted” second-half forecast is partially a function of first-half strength that may have led the company to dial back full-year margin expectations, Fowler said. However, macro conditions and company-specific metrics continue to support a favorable investment thesis, said Fowler, who maintained an “overweight” rating on UPS shares with a 12-month price target of $235 a share.
Rearview mirror though they may be, UPS pushed out impressive second-quarter results that CEO Carol Tomé said exceeded management’s expectations. The company reported a 14% increase in revenue to $23.4 billion, with adjusted operating income up 40.8% to $3.3 billion and diluted earnings per share up 43.7% to $3.05, 34 cents higher than the median estimates of analysts who were polled on Barchart. UPS cracked the $3 billion quarterly mark for consolidated operating income for the first time.
International parcel revenue led the way in percentage terms, rising 30% to $4.8 billion. Adjusted operating margin rose 24%, with adjusted operating profits up to $1.19 billion from $842 million, UPS said. The U.S. domestic package segment, its largest, posted revenue of $14.4 billion, up 10.2%. Revenue per piece increased 13.4% on strong across-the-board product gains, UPS said. Adjusted operating margin grew 11.6%, while adjusted operating profit rose to $1.675 billion from $1.25 billion, a more than 30% year-on-year increase.
UPS’ Supply Chain Solutions segment, which comprises all of the company’s nonpackage businesses, posted a 14.3% increase in revenue on strong demand across its lines, UPS said. Adjusted operating margin rose 9.7%, while adjusted operating profit rose to $408 million from $207 million. The unit’s name was changed to reflect the $800 million sale of UPS’ former LTL unit to Canadian firm TFI International Inc. (NYSE:TFI). The deal closed on April 30, during UPS’ second quarter.
Average daily volumes for the company’s business-to-business (B2B) segment rose 25.7% over year-earlier figures. The 2020 results were heavily impacted by pandemic-related lockdowns that put a near halt on B2B activity.
UPS is awash in free cash after generating $6.8 billion in the first half of 2021 alone, more than any full year in its 114-year history. The massive hoard gives UPS many options, such as dividend hikes, share buybacks and acquisitions, though the latter appears unlikely for the foreseeable future.
“We are opportunity rich,” Tomé said.
UPS is benefiting from a U.S. economy that has recovered faster than the company had expected — and that remains on bullish ground. The federal government’s retail inventory-to-sales ratio, which measures how much inventories that retailers have on hand relative to sales, hit 1.09 in May, a historically low level. The figure means that retailers have less than five weeks of inventories on hand and that they will spend at least the next few quarters replenishing their almost-bare stockpiles.