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United Parcel Service, Inc. (NYSE:UPS) Q1 2023 Earnings Call Transcript

United Parcel Service, Inc. (NYSE:UPS) Q1 2023 Earnings Call Transcript April 25, 2023

United Parcel Service, Inc. misses on earnings expectations. Reported EPS is $2.2 EPS, expectations were $2.21.

Operator: Good morning. My name is Steven and I will be your facilitator today. I would like to welcome everyone to the UPS Investor Relations First Quarter 2023 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. And after the speakers’ remarks, there will be a question-and-answer period. It’s now my pleasure to turn the floor over to our host, Mr. Ken Cook, Investor Relations Officer. Sir, the floor is yours.

Ken Cook: Good morning, and welcome to the UPS first quarter 2023 earnings call. Joining me today are Carol Tomé, our CEO; Brian Newman, our CFO; and a few additional members of our executive leadership team. Before we begin, I want to remind you that some of the comments we’ll make today are forward-looking statements within the federal securities laws and address our expectations for the future performance or operating results of our company. These statements are subject to risks and uncertainties, which are described in our 2022 Form 10-K and other reports we file with or furnish to the Securities and Exchange Commission. These reports, when filed, are available on the UPS Investor Relations website and from the SEC. Unless stated otherwise, our discussion refers to adjusted results.

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For the third quarter of 2023, GAAP results include after-tax transformation and other charges of $9 million or $0.01 per diluted share. A reconciliation to GAAP financial results is available on the UPS Investor Relations website along with the webcast of today’s call. Following our prepared remarks, we will take questions from those joining us via the teleconference. Please ask only one question so that we may allow as many as possible to participate. You may rejoin the queue for the opportunity to ask an additional question. And now, I’ll turn the call over to Carol.

Carol Tomé: Thank you, Ken, and good morning. Let me begin by thanking UPSers for once again delivering industry-leading service to our customers. Service defines UPS. It is one of our values and I’m proud of our team who continue to make it a key priority. Another company value is safety. UPS drivers are among the safest in the industry and every year we invest millions of dollars in safe driving education and training. Our Circle of Honor program recognizes drivers who have achieved 25 years or more of accident-free driving. This year we inducted more than 1,200 UPS drivers into the Circle of Honor, bringing the total to more than 10,400 around the globe. Congratulations to these drivers on their achievement. Turning to our results.

2023 is proving to be an interesting year. In the U.S., relative to our base plan, volume was higher than we expected in January, close to our plan in February, and then moved significantly lower than our plan in March as retail sales contracted and we saw a shift in consumer spending. For example, food as a percentage of household budgets reached 9% in the first quarter compared to 7% a couple of years ago. U.S. discretionary sales are lagging grocery and consumable sales and disposable income is shifting away from goods to services. Outside of the U.S., export activity out of Asia remained weak, which negatively impacted revenue in both international and supply chain solutions. In response, we focused on controlling what we could control.

We remained in disciplined on price. We increased penetration in the most attractive parts of the market. We managed the network with agility, we drove productivity and we stayed on strategy. Looking at our first quarter financial results versus last year, consolidated revenue was $22.9 billion, down 6%. Operating profit was $2.6 billion, a decrease of 22.8% and consolidated operating margin was 11.1%, a decline of 250 basis points. While revenue fell short of our base plan due to a relentless focus on productivity both operating profit and operating margin were in line with our base plan. Moving to our strategic update, through our Customer First, People Led, Innovation Driven strategy, we are investing to improve the customer experience and drive efficiency.

Starting with Customer First. Key investments here are driving growth in targeted customer segments like SMBs and healthcare. Looking at SMBs, we continue to invest in the international expansion of our Digital Access Program or DAP. We now have 16 countries producing DAP revenue. In the first quarter, total DAP revenue was up 51.5% compared to last year, and we are on track to generate around $3 billion in DAP revenue this year. Did you know that in the U.S. about one out of every four DAP packages enters our network through a UPS store with more than 5,100 locations in the U.S., UPS stores are strategic assets. In fact, 85% of the U.S. population is within 10 miles of a store, giving customers ultra convenient entry points to the UPS network, whether they’re in SMB shipping and item they’ve sold online or a customer returning an item they buy.

Given the strategic importance of these stores, we are leaning into investments here to improve the customer experience. For example, the stores are rolling out self-service kiosks that enable customers to bypass the counter when they have shipments and returns, even returns with no box or no label. These kiosks make it easier for customers to get in and get out of the store. We’ve rolled out nearly 200 kiosks so far and we’ll deploy 1,000 by the end of October this year and we’re not stopping there. Another area of focus is improving the claims process, which used to be a hassle for both customers and franchisees. In March, the UPS store launched an online claims portal to all U.S. locations that’s designed specifically for the needs of the store shipper.

With this portal, claims that used to take weeks for resolution are now resolved within an average of about two gains. One final comment on SMBs. In the first quarter, SMBs including platforms made up 29.6% of our total U.S. volume. This is the 11th consecutive quarter of increased SMB penetration and it’s the highest level we’ve seen in more than seven years. Turning to healthcare. In the first quarter of 2023, we expanded our global footprint by opening nearly 1 million square feet of dedicated healthcare space, including our first facility in Germany. This facility provides customers a broad range of temperature sensitive and handling solutions. Its location in the center of Germany connects our customer shipment, the fast growing European healthcare market.

The facility is also closed to our European air hub in Cologne, enabling customers to leverage the speed and reach of our global network. As a reminder, in the fourth quarter of 2022, we completed the acquisition of Bomi Group and to date, revenue and cost synergy are running ahead of target. Further, we are continuing to invest in the global expansion of UPS Premier, which is now available in 45 countries with four more to be added this year. Our goal is to become the number one complex healthcare logistics provider in the world to help us get there who plan to open a total of seven dedicated healthcare facilities this year. In the first quarter, revenue from our healthcare portfolio reached $2.4 billion and we expect to generate over $10 billion in healthcare revenue in 2023.

Turning to People Led, let me discuss the progress of our negotiations with the Teamsters. Negotiations on a new contract with the Teamsters are underway and good progress has been made on many of our local supplemental agreements. Together, we’ve set up five subcommittees at the national bargaining table to take on key areas of the contract, which enables us to move faster. We are aligned on several key issues like solving the staffing needs for weekend deliveries and ways to mitigate the summer heat in our package delivery vehicle. While we expect to hear a great deal of noise during the negotiation, I remain confident that a win-win-win contract is very achievable and that UPS and the Teamsters will reach agreement by the end of July. Now let’s move to the last leg of our strategy Innovation Driven.

26 Biggest Malls in the World in 2017
26 Biggest Malls in the World in 2017

Copyright: lightpoet / 123RF Stock Photo

We have the best, most efficient global integrated network in the world, and we are getting even better. Today, we operate our network with more agility than ever before, and when it comes to productivity, we are relentless about creating a virtuous cycle of improvement in our network. For example, our total service plan, which addresses running a predictable on-time network has delivered continued productivity improvements since being introduced last year. Our massive and highly complex network naturally generates efficiency when volume increases. But when volume levels drop, historically, it’s been harder to generate productivity improvement. With total service plans, we have driven productivity even with declining volume. In the first quarter, U.S. volume declined by 5.4%, but ours declined even further, which resulted in improved productivity as measured by pieces per hour.

As we’ve discussed last quarter, we’ve accelerated investment in our Smart Package Smart Facility RFID solution and plan to complete deployment in more than 900 buildings across the U.S. by the end of October. Throughout the process, we’ve continued to learn and improve, which has enabled stronger results than we originally expected. In the facilities where we have this technology, we’ve cut the frequency of misloads from around 1-in-400 packages to one-in-1,000 packages, which reduces miles, handles and costs and it improves, but the customer and employee experience. Innovation driven is also about combining digital capabilities with our integrated network to improve the customer experience and efficiency. Our upstream delivery density solution checks both boxes.

This month, we are onboarding our second large national retailer, which gives us more opportunity to increase density as we can match volume in the UPS network with orders of participating customers. It’s still early days of this initiative. As we learn, we continue to adjust the match rate algorithm and we are happy with the results. Lastly, our innovation driven initiatives are moving us towards our 2050 carbon neutrality goal. We are focused on the decarbonization of our global supply chain. In 2022, our Scope 1, 2, and 3 CO2 emissions declined by 6.9% from 2021. We’ve been investing in alternative fuel for more than 20 years and operate more than 15,600 alternative fuel and advanced technology vehicles. Recently, we took delivery of 10 fully electric class 8 semi trucks in California.

These trucks are quiet and they are the first zero emission semis to run in our UPS fleet. Our 2022 sustainability report was published on April 12. This is our 21st annual sustainability report, and you can find it on about.ups.com. Moving to our outlook for 2023, last quarter, we provided a range for our 2023 financial target. As we’ve discussed, there’s been a deceleration in U.S. retail sales growth in certain non-U.S. markets remain challenged. As a result, we now expect to be at the low end of our previously provided revenue and operating profit margin range. Brian will share more detail in a moment. I’ve led three difficult times before and I’ve seen the power of making the right decisions and the pitfalls of making wrong decisions.

In uncertain market conditions, it’s easy to fall into the trap of managing the business for the short-term. While we will control what we can control, we will also stay on strategy. Over the past three years, we have fundamentally improved nearly every aspect of our business and we are just getting started. UPSs are the best in the industry, and because of them, I am convinced we will come out of this cycle faster, stronger, and with a wider lead on our competition. With that, thank you for listening, and now, I’ll turn the call over to Brian.

Brian Newman: Thanks, Carol, and good morning. In my comments, I’ll cover four areas, starting with the macro environment, then our first quarter results, next I’ll cover cash and shareholder returns, and lastly, I’ll review our updated financial outlook for 2023. Okay, let’s start with a macro. In the first quarter, the macro environment was challenging from both a commercial and consumer perspective. The growth rate for U.S. manufacturing production fell throughout the quarter and was down 0.9% in March year-over-year. On the consumer side of the U.S. economy, the growth rate on services spending is continuing to outpace the growth rate on good spending, and within the goods bucket, consumer spent more on essential items like groceries, which tend to be purchased in store.

These factors plus a five point drop in consumer sentiment from February to March contributed to the reduction in our volume levels. Outside the U.S. in the first quarter, Asia exports remained weak while Europe narrowly avoided a winter recession. In the face of all this, we responded with agility and remain focused on controlling what we could control to deliver great service for our customers and bottom line results for shareholders. In the first quarter, consolidated revenue was $22.9 billion, down 6% from last year and slightly below our base plan expectations. Operating profit was $2.6 billion, a decrease of 22.8%, however, we achieved our base plan operating profit. Consolidated operating margin was 11.1%, a decline of 250 basis points compared to last year.

For the first quarter, diluted earnings per share was $2.20 down 27.9% from the same period last year. Now, let’s look at our business segments. In U.S. Domestic, revenue quality initiatives nearly offset the decrease in volume and as the decline in volume accelerated toward the end of the quarter, we responded quickly by adjusting the network to eliminate costs while maintaining our industry leading service levels. In the first quarter, we expected average daily volume to decline between 3% and 4%. For the quarter, average daily volume was down 5.4% year-over-year, primarily because volume in March moved lower than we expected. Looking at mix in the first quarter, we saw lower volume across all industry sectors with the largest declines from retail and high-tech.

B2C average daily volume declined 5.5% compared to last year, and B2B average daily volume declined 5.4%. A bright spot in B2B in the quarter was returns, which was up 6.8% year-over-year. In the first quarter, B2B represented 42.7% of our volume, which was unchanged from a year ago. Additionally, the shift in product mix from air to ground that we saw in the fourth quarter of 2022 continued in the first quarter as customers made cost tradeoffs and took advantage of the speed improvements we made in our ground network and further leveraged our SurePost product. Compared to the first quarter of last year, total air average daily volume was down 16.7%, ground declined 3% and within ground SurePost grew 1.8%. Looking at customer mix, SMB average daily volume declined significantly less than our enterprise customers in the first quarter.

SMBs, including platforms made up 29.6% of our total U.S. volume, an increase of 120 basis points year-over-year. For the quarter, U.S. Domestic generated revenue of $15 billion down 0.9%. Revenue per piece increased 4.8%, nearly offsetting the decline in volume. The combination of base rates and customer mix increase the revenue per piece growth rate by 500 basis points driven by strong keep rates from our general rate increase and increased SMB penetration. Fuel drove 200 basis points of the revenue per piece growth rate increase. Remaining factors reduced the revenue per piece growth rate by 220 basis points driven by the combination of negative product mix with ground packages outpacing air growth and lighter package weights. Turning to cost, total expense was relatively flat with an increase of 0.6% or $80 million in the first quarter.

Higher union wage and benefit rates increased expense by over $300 million, primarily from a 6.1% increase in average union wage rates driven by the annual pay increase for our Teamster employees that went into effect in August of 2022. The U.S. Domestic team did an excellent job pulling cost out of the network in response to lower volume. We managed hours down 5.6%, which was more than the decrease in average daily volume, and we reduced headcounts throughout the quarter as volume growth rates decline. Together, these actions reduced expenses by more than $220 million, partially offsetting the increase in wage and benefit rates. Additionally, we reduced purchase transportation by $100 million, primarily from utilizing UPS feeder drivers to support our Fastest Ground Ever and from continued optimization efforts, which enabled us to reduce trailer loads per day by 7.5% compared to the same period last year.

The remaining variance was driven by multiple factors including maintenance and depreciation. The U.S. domestic segment delivered $1.5 billion in operating profit, which was slightly above our base plan and down 12.7% compared to the first quarter of 2022. And operating margin was 9.9%. Moving to our international segment, we expected the macro environment to be bumpy and it was. Looking at Asia, export activity started off very weak due to the extended lunar New Year holiday. It gradually recovered through the quarter, but at a slower pace than we anticipated. In Europe, the macro environment was a little better than we expected, which helped offset the weakness in Asia relative to our base plan. In the first quarter, international total average daily volume came in as expected and was down 6.2% year-over-year.

Domestic average daily volume was down 9.5%, which drove three quarters of the total average daily volume decline. Total export average daily volume declined 2.8% on a year-over-year basis driven by declines in retail and high tech market demand. Asia export average daily volume was down 8.9% and included a 20% year-over-year decline on the China to U.S. lane. Through the first quarter, we remained agile and we flexed the network to match demand. Reduced Asia block hours by more than the decline in Asia export volume and delivered excellent service to our customers. In the first quarter, international revenue was $4.5 billion, down 6.8% from last year due to the decline in volume and a $161 million negative revenue impact from a stronger U.S. dollar.

Revenue per piece was relatively flat year-over-year, but there were a number of moving parts including a 370 basis points decline due to currency and a 180 basis points decline from demand related surcharges. These were offset by an increase in the fuel surcharge of 230 basis points and an increase of 330 basis points due to the combination of a high GRI keep rate and a favorable product mix as export volume outperformed domestic volume. Operating profit in the international segment was $806 million, down $314 million from the same period last year, primarily due to the decline in exports out of Asia and included a $97 million reduction in demand related surcharge revenue and a $51 million negative operating profit impact from currency. Operating margin in the first quarter was 17.7%.

Now looking at supply chain solutions. In the first quarter, revenue was $3.4 billion, down $983 million year-over-year. Looking at key drivers. In forwarding, softer global demand, especially out of Asia, drove down market rates and volume resulting in lower revenue and operating profit. We are continuing to manage buy/sell spreads and have taken steps to reduce operating costs in this business. Logistics delivered revenue growth driven by gains in our healthcare logistics and clinical trials business and increased operating profit. In the first quarter, supply chain solutions generated an operating profit of $258 million and an operating margin of 7.6%. Walking through the rest of the income statement, we had 188 million of interest expense.

Our other pension income was $66 million and our effective tax rate for the first quarter was 24.8%, which was less than we anticipated in our base plan due to lower tax impacts from our employee stock awards. Now let’s turn to cash and shareholder returns. In the first quarter, we generated $2.4 billion in cash from operations. Free cash flow for the period was $1.8 billion, including our annual pension contributions of $1.2 billion that we made in the first quarter. Also, in the first quarter, we issued $2.5 billion in long-term debt that we are using to pay off debt maturing in 2023. And in the first quarter, UPS distributed $1.3 billion in dividends and completed $751 million in share buybacks. Moving to our outlook for the full year 2023.

In January, we provided a range for our 2023 financial targets due to the uncertain macroeconomic environment we saw at that time. Since then, the volume environment has deteriorated, especially in the U.S., driven by continued challenging macro conditions and changes in consumer behavior. As a result, we expect full year revenue and operating margin to be at the low end of the previously provided range. For the full year 2023, we expect consolidated revenues of around $97 billion and consolidated operating margin of around 12.8% with about 56% of our operating profit coming in the second half of the year. In U.S. domestic, we expect full year volume to decline around 3% versus 2022 with revenue per piece growth yearly offsetting the decline in volume and operating margin is expected to be around 11%.

In international, we anticipate both volume and revenue to be down by around 4% and we expect to generate an operating margin of around 20%. And in supply chain solutions, we expect full year revenue to be around $14.3 billion, and operating margin is expected to be around 10%. We have proven our ability to adapt in a dynamic environment. We have many levers to pull on the cost side and we will continue to control what we can control by delivering industry leading service and remaining disciplined on revenue quality. We will also continue investing in growth and efficiency initiatives like international DAP, healthcare and Smart Package smart facility, which will help us come out of this economic cycle faster and stronger. Specifically, now that our volume is trending at the downside of our range, we are executing our plan to take out semi variable and fixed costs.

Including in the U.S. air network, we are adjusting package flows to maximize utilization on our next day flights, which enables us to reduce block hours in our two-day operation. On the ground, we are pulling more volume into our large regional hubs, further leveraging the automation in those buildings and enabling us to eliminate sorts in smaller buildings. Driving more consolidation on the ground could potentially allow us to reduce our overall building footprint in the U.S. Internationally, based on the volume levels over the last couple of quarters, we’ve further reduced scheduled flights to reflect lower market demand while ensuring we maintain agility in the network to quickly add flights where needed if volume returns more strongly than we expect.

Across our global business, we will continue to manage headcount with volume levels. And in terms of overhead, we see opportunities to further reduce costs by leveraging technology. Now let’s turn to capital allocation. Our plans have not changed. We will continue to make long-term investments to support our strategy and capture growth coming out of this cycle. We still expect 2023 capital expenditures to be about $5.3 billion, including investments in automation, and we’ll add 2.3 million square feet of healthcare logistics space to our global network this year. We’ll also complete the deployment of the first phase of Smart Package Smart Facility in the U.S., expand DAP internationally and continue building out our logistics as a service platform.

We are still planning to pay out around $5.4 billion in dividends in 2023 subject to Board approval. We still plan to buy back around $3 billion of our shares. And lastly, our effective tax rate for the full year is expected to be around 23.5%. In closing, despite the challenging macro backdrop, we will continue to provide industry leading service to our customers and we will stay on strategy. We are investing to make our network even more efficient and to strengthen our customer value proposition to enable us to capture growth coming out of this cycle. Thank you. And operator, please open the lines.

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