Trading on almost 18 times Wall Street estimates for earnings this year, and with a recent history of disappointing the market, United Parcel Service(NYSE: UPS) stock may seem expensive. Still, the company is highly likely to have passed an inflection point in its earnings in 2024. As such, UPS is less expensive than it might seem.
UPS passes an inflection point
UPS earnings represent a tale of two halves in 2024. The first-half adjusted operating profit declined by 30.3% compared to the first half of 2023. Meanwhile, management's forecast for the fourth quarter of 2024 implies that the second-half adjusted operating profit will grow slightly more than 12.1% compared to the second half of 2023.
Data source: UPS presentations. Chart by author.
Why UPS is set to grow profits
I've discussed UPS at more length elsewhere, concluding that it is muddling its way through a difficult period. Overcapacity in the industry creates conditions where it's taking on more revenue at lower revenue-per-piece deliveries. Still, its underlying strategy of targeting growth in areas such as healthcare and small and medium-sized businesses (SMB) is intact, as are its cost-cutting measures and productivity-enhancing investments.
As delivery volume growth improves and package delivery companies (including UPS) remove unnecessary capacity from the market, the industry's overcapacity will fade, leading to greater pricing power. However, there's a more immediate reason why UPS' profits will improve in 2025, and it comes down to lapping the cost increases that came with the improved labor contract in 2023.
UPS suffered a revenue hit in the second and third quarters of 2023 as the protracted dispute led customers to divert deliveries in fear of strikes. The eventual settlement added costs in the third quarter, so UPS couldn't pull the lever to cut costs even as its revenue declined.
Data source: UPS presentations. Chart by author.
However, UPS is now lapping the cost increase in the third quarter of 2023, and its compensation and benefits cost growth is much more in line with revenue growth -- a reason why UPS profits are growing again.
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Lee Samaha has no position in any of the stocks mentioned. The Motley Fool recommends United Parcel Service. The Motley Fool has a disclosure policy.
