UPS Earnings: Margins Disappoint on Higher Than Expected Shipment Diversions

UPS UPS third-quarter top line fell 13% year over year (removing foreign exchange); this was below our forecast because of greater than expected domestic package volume diversions resulting from the potential Teamster’s strike. Relative to third-quarter 2022, the revenue decline stems from lower overall package activity, rate and demand normalization for the truck brokerage and global forwarding operations, and lower fuel surcharges. That said, core pricing remains positive.

Total average daily package volume plummeted 11% (worse than last quarter) on domestic U.S. freight diversions (shipper concern over union negotiations), muted retailer restocking, softer U.S. industrial production, and less robust macroeconomic conditions across Europe. UPS is winning back diverted volumes, which is boosting sequential October volumes, but we still suspect FedEx will retain a portion of the business it won from UPS.

Total adjusted operating margin contracted meaningfully year over year on lost operating leverage and painful wage inflation from the new union contract. We’ve been anticipating these headwinds, but domestic package margin nonetheless comfortably missed our forecast. On the positive side, fourth-quarter domestic margin guidance wasn’t drastically far off our expected run rate.

We will be tempering our near-term forecasts, especially for domestic package, in large part because of higher than anticipated diversions in the quarter and related lost leverage. Our model adjustments will likely have a slight downward impact on our $172 fair value estimate, partly offset by the time value of money. Following the pullback in the share price over the past several months, UPS now looks modestly undervalued relative to our longer-term free cash flow growth forecasts.