Is UPS Stock a Buy?

UPS (NYSE: UPS) stock is attracting a lot of attention from value investors, and rightly so. The stock's 4.5% dividend yield will please income-seeking investors, and the company has plenty of recovery potential as the economy, hopefully, improves and capacity gets taken out of the parcel delivery sector. There's a lot to like about UPS, but is it time to pull the trigger and buy the stock as it trades around the $137 mark? Here's the lowdown.

Investor concern over UPS

Investors were naturally cautious going into the company's third-quarter earnings. Its rival, FedEx (NYSE: FDX), had already disappointed the market by lowering its full-year 2025 guidance on its first-quarter fiscal 2025 earnings report in September. FedEx management's commentary alluded to weaker-than-expected end markets, a shift to lower-margin delivery options, and particular weakness in the lucrative business-to-business (B2B) market.

This spelled trouble ahead for UPS because UPS significantly lowered its full-year guidance in July.

What happened in UPS' third quarter

In the end, UPS' end market conditions were similar to those discussed by FedEx in September. However, UPS reassured investors by executing well in a challenging environment while more or less maintaining its full-year operating earnings guidance.

CEO Carol Tome said the macroeconomic environment was "slightly worse than we expected" and referenced a slowdown in manufacturing activity and industrial production. Unfortunately, the unfavorable environment continues to negatively impact UPS' revenue per package. The chart below shows data from the transportation stock's core U.S. domestic package segment, which tells the tale of UPS' third quarter.

It also reveals operational conditions seemingly contrary to management's "better not bigger" guiding framework. Under the framework, UPS is supposed to focus on growing more profitable deliveries in targeted end markets such as healthcare and small and medium-sized businesses (SMBs). While UPS is still doing that, challenging end-market conditions have meant customers are shifting to lower-cost delivery options, and UPS has seen strong growth in lower-margin deliveries.

Image source: Getty Images.

The end result was a 6.5% year-over-year increase in volume and a 2.2% year-over-year decline in average revenue per piece (RPP) in the U.S. domestic margin segment. Note that this is the opposite dynamic to 2022, when RPP was growing and volumes declined -- a scenario more representative of the "better not bigger" framework.

Ultimately, the mix of volume growth and declining RPP led to a 5.8% year-over-year increase in revenue in the third quarter. In addition, UPS did an excellent job of reducing cost per piece (CPP) in the quarter, with a non-GAAP (adjusted) CPP lower by 4.1% year over year.

Data source: UPS presentations. Chart by author.

Summarizing the U.S. domestic package segment on a year-over-year basis:

• Volume up 6.5%
• RPP down 2.2%, with CPP down 4.1%
• Revenue up 5.8%
• Non-GAAP operating margin up to 6.7% from 4.9% in the same period last year
• Non-GAAP operating profit increased 46.5% year over year to $974 million

It's clear that UPS managed to control costs to expand margins even as RPP declined, so the benefit of volume growth flowed through into increased profit growth.

Trading in the international segment was less exciting, with volume down 0.6% year over year, but RPP increased by 2.5%, leading to a 17.3% increase in adjusted operating profit to $792 million.

Image source: Getty Images.

What it means to investors

In summary, UPS is struggling through a challenging trading environment, and its increased volume and lower RPP performance runs contrary to management's "better not bigger" framework. That said, UPS can do little about its end markets and is taking action to improve pricing and contain costs by cutting jobs, rationalizing plants, and taking other productivity-enhancing measures.

In addition, UPS is reducing its capacity to align with market conditions. Also, Tome noted on the earnings call that "we see capacity rationalization happening in other parts of the market as well." As such, the industry appears to be working through overcapacity as volume (albeit lower-margin volume) increases. That's a positive sign, as is UPS' ability to improve margin.

In fact, management improved its full-year margin guidance, although lowered revenue expectations mean its full-year profit guidance is similar to that of three months ago.

Data source: UPS presentation, *author's interpretation.

Meeting the full-year numbers won't be easy. They imply operating earnings of $2.95 billion compared to $1.98 billion in the third quarter. Still, many UPS metrics (CPP, volumes, and margin) are moving in the right direction, and volume growth plus capacity reduction usually spells increased pricing power in the industry down the line.

As such, trading on slightly more than 18 times full-year earnings expectations, UPS looks slightly undervalued, even as risk remains to its full-year outlook. The company is muddling through the trading environment, but most of its metrics are moving in the right direction.

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Lee Samaha has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends FedEx. The Motley Fool recommends United Parcel Service. The Motley Fool has a disclosure policy.