United Parcel Service Is Setting Up for Another Fall

Key Points

• United Parcel Service had another weak quarter and isn't guiding for much better later in the year. 
• Cash flow is sound but insufficient to support an outlook for robust dividend increases or share repurchases. 
• The company is building leverage for a business rebound, but the stock could move lower before the rebound begins. 

If United Parcel Service NYSE: UPS can be used as a leading indicator of the economy and S&P 500 performance, it sends a mixed signal. On the one hand, operational improvements and increased efficiency set UPS up for leverage growth when its business rebounds. On the other, business conditions are rough, the guidance may be optimistic, and the rebound is still far off. Capital returns are safe, but the stock price isn't. Although the analysts' consensus continues to forecast a double-digit upside, it is falling due to revisions leading the market lower, and the technical picture is not promising. 

UPS Struggles in Q1, Reaffirms Guidance

UPS struggled in Q1 with weakness in all segments, impacting the top and bottom lines. The company reported $21.7 billion in revenue for a decline of $5.3 billion YOY that missed the analyst consensus by 120 basis points. The weakness was led by the International segment, which fell by 6.3% on a 5.8% decline in volume, followed by a 5.3% contraction in Supply Chain Solutions and a 5% decline in the core US Domestic segment. US volume fell by 3.2%; deleveraging prices impacted Supply Chain Solutions. 

Margin is a mixed bag of results ultimately unfavorable to the market today. The company reported a better-than-expected consolidated adjusted operating margin and strength on the bottom line relative to the consensus reported by Marketbeat, but earnings are weak. The company's margin was deleveraged by 310 basis points YOY due to lower volume, prices, and mix, which efficiencies could not overcome. The company is building leverage for the rebound but needs the rebound for traction. The Q1 $1.43 beat by $0.08 but is down $0.77 compared to last year or 35% compared to the 5.3% top-line contraction. 

Guidance was reaffirmed despite the Q1 revenue weakness and persistent economic headwinds. The company is forecasting a return to growth by the end of the year that should leave revenue in the range of $92 to $94.5 billion. The range's midpoint is above the consensus but likely optimistic, given the FOMC outlook. The company's guidance depends on an economic shift in the back half of the year that is unlikely without an interest rate cut. The odds of an interest rate cut in 2024 have fallen drastically over the last two months and will likely continue to fall as inflation data comes.  

UPS Snags Postal Service Business

UPS made headlines by snagging US Postal Service Business from FedEx. The company's CEO says the business will be margin accretive within the first year and for the contract's life. The contract is for five and a half years, starting September of 2024 and will begin impacting operations in Q4, just in time for the holidays. The deal will positively impact revenue, but its impact on earnings is questionable despite management's claims. They believe the business aligns with its network cost-effectively. UPS says it will hire more pilots to cover the load but will not have to buy more planes. UPS has not commented on the terms of the deal. 

UPS Capital Returns are Safe: Distribution Growth Isn't

UPS is a solid dividend-paying stock with a high yield of nearly 4.5%. The yield is high because of the stock price meltdown and the payout ratio, which is also high. At 74%, the dividend is sustainable, but cash flow is pinched and caused a slowdown in the pace of distribution increases. The 5-year CAGR is double-digit, but the last penny increase is worth only 0.6%, and another tepid increase is forecast for this year. Share repurchases compound dividends; repurchases reduced the count by about 1% on average at the end of Q1. 

The price action in UPS is up following the release and shows a rising level of support within a newly formed trading range. However, the new range is at the end of a downtrend and looks like a Bearish Triangle. This pattern could lead to a continuation of the downtrend and a new low for the stock price. The critical support is near $135; a move below could lower the market to $120 or lower. Critical resistance is the compounded effect of the 30-day EMA, the 150-day EMA, and the top of the trading range near $160. It will take a move above $160 to alter the technical outlook for range-bound trading with a chance for a new low.