UPS Earnings Preview: Are investors over-prepared for weak results?

UPS is approaching its Q3 earnings report with investor sentiment cautious, largely due to its recent Q2 earnings miss and the significant miss reported by its peer FedEx last month. The market is wary of whether UPS can meet its earnings per share (EPS) consensus of $1.63 and revenue expectation of $22.10 billion.

The results, which are expected before the market opens tomorrow, will be scrutinized closely, especially in light of UPS’s challenges with revenue growth and operating margins.

In Q2, UPS experienced its first earnings miss since Q1 2020, with revenue dipping 1.1% year-over-year to $21.82 billion, which came in slightly below analyst projections.

The greater concern, however, was the company’s decision to reduce its FY24 adjusted operating margin outlook to 9.4%, a significant drop from the previous guidance of 10.0-10.6%. This margin compression reflects broader difficulties UPS faces in managing costs and revenue generation within a highly competitive logistics sector.

One positive note from Q2 was the increase in average daily volume (ADV) in the U.S., which grew 0.7% year-over-year, marking the first positive volume growth since Q4 2021. This sequential growth of 390 basis points was primarily led by the B2C (business-to-consumer) segment, which saw a 4.8% increase year-over-year, making up 58.5% of total volume. The rise was largely due to the influx of new e-commerce clients joining UPS’s network, signaling that the company is successfully tapping into the expanding e-commerce market.

However, the benefits of this volume increase were offset by customers opting for lower-cost services, such as trading down from air to ground shipping or from ground to UPS’s low-cost SurePost option.

This shift in service preference indicates a continuing trend of customers seeking cost efficiency, which in turn is impacting UPS’s revenue per piece and overall margins.

The company’s guidance suggests that the product mix in the second half of 2024 will remain skewed towards lower-margin services, thus maintaining pressure on operating margins and revenue growth. While UPS projects mid-single-digit growth in U.S. ADV for the remainder of the year, the persistent product mix shift is likely to limit profitability.

UPS's concerns are further amplified by FedEx's recent Q1 earnings results, which highlighted a challenging demand environment, especially within the U.S. domestic package market.

FedEx noted that a shift from higher-margin priority services to deferred, lower-margin services constrained yield growth, echoing the challenges UPS is facing. Given these parallels, the market is understandably cautious about UPS’s ability to navigate the current demand landscape without seeing a similar impact on its earnings.

In terms of stock performance, UPS shares have been trending downward since early January, reflecting investor wariness. The Q2 miss and the subsequent lowering of operating margin guidance have weighed heavily on investor confidence.

Additionally, FedEx’s underperformance has contributed to a broader negative sentiment around logistics and delivery stocks, given the two companies’ comparable service offerings and overlapping market dynamics.

Looking ahead to the Q3 earnings report, several key factors will be critical in shaping investor reaction. First, UPS’s ability to demonstrate any improvement in revenue per piece will be closely monitored.

A positive shift here could indicate that the company is successfully managing the product mix to optimize profitability. Additionally, any signs of further volume growth, particularly in high-margin segments like air services or premium ground options, could provide a boost to market confidence.

Another focal point will be UPS’s forward guidance. Investors will be interested in any updates or revisions to its FY24 revenue and margin outlook, as these will provide insight into whether the Q2 results were an anomaly or part of a broader trend. UPS’s previous guidance of approximately $93 billion in revenue and a 9.4% adjusted operating margin will likely serve as benchmarks against which the market will gauge any optimism or caution in management’s outlook.

While there are some positive signs, such as the increase in U.S. ADV and growth in e-commerce volume, UPS faces significant headwinds that could continue to pressure its stock price and financial performance.

The cautious sentiment among investors is justified given recent industry trends and FedEx’s results, and the upcoming earnings report will be a critical indicator of whether UPS can stabilize its margins and revenue trajectory. Investors should prepare for potential volatility as UPS navigates these complex dynamics and attempts to realign its service offerings with current market demand.