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UPS (UPS -13%) did not deliver as hoped. The delivery giant missed badly on EPS, its first miss since 1Q20. Revenue dipped 1.1% yr/yr to $21.82 bln, which was modestly below analyst expectations. While its FY24 revenue guidance of $93 bln is generally in-line with prior guidance of $92.0-94.5 bln, it does not tell the important part of the story. The bigger problem is that UPS reduced its FY24 operating margin outlook pretty significantly to 9.4% from 10.0-10.6%.

• Let's start with some good news. Q2 marked an important turning point for the business because US average daily volume (ADV) increased 0.7% yr/yr. This marked a return to positive volume growth for the first time since 4Q21. And sequentially, ADV grew 390 bps. Growth was led by B2C with volume up 4.8% yr/yr and it made up 58.5% of total volume. This growth was driven in large part by several new e-commerce customers that entered the UPS network. B2B ADV fell 4.6%.
• While it was good to see volume growth, there was a catch -- customers traded down to lower cost services. Specifically, UPS saw customers shift from air to ground and from ground to SurePost. Within ground, SurePost ADV grew 25% yr/yr, driven by new shippers product choices, product trade downs and easier comparisons. This trade down hurt margins and helps explain the large EPS miss. Also impacting margins yr/yr was high labor costs from its new Teamsters contract.
• In terms of its outlook, volume characteristics are expected to have a weaker mix with lower margin services making up a larger part of total sales. That is why UPS lowered its FY24 operating margin guidance. UPS expects US ADV in 2H to grow by mid-single-digits. However, product mix is expected to continue to pressure revenue per piece. Despite all of this, UPS expects to exit the year with a US operating margin of 10%.
• Quickly, in addition to earnings, UPS announced it will acquire Estafeta, a Mexican express delivery company. UPS noted that global supply chains are shifting and Mexico's role in global trade is growing. Also, Mexican SMB and manufacturing sectors are looking for reliable access to the US market. As the shift to nearshoring continues, UPS believes its combined business will give customers in Mexico unprecedented access to global markets.

Overall, this report from UPS was a letdown for investors. The large EPS miss was pretty shocking, given its rarity at UPS but also because FedEx (FDX) traded sharply higher in late June after reporting a nice EPS beat for Q4 (May). However, it does explain our bewilderment at the time for why UPS did not join in FDX's move last month. Clearly, investors were nervous about UPS's Q2 report and those concerns were borne out. It seems customers are trading down and that is hurting UPS's margins.