UPS Drops Off S&P's Triple-A List

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From Standard & Poor's RatingsDirect

The board of directors has authorized an increase in its share repurchase program to $10 billion from the previously authorized $2 billion level. The company expects to complete the $10 billion in share repurchases over the next 24 months.

Strong Position in Package Delivery

Standard & Poor's expects the company to operate within its targeted band and to curtail its share repurchase plans and acquisition activities if they cause credit metrics to fall below expectations built into current ratings. Debt leverage (as measured by adjusted debt to capital) will more than double following the implementation of the new financial policy, but will still support the new rating level, given the strong cash flow generated by the company and its substantial sources of liquidity. Also factored into our analysis is the expected impact of the new contract recently negotiated with the International Brotherhood of Teamsters, and the slowing U.S. economy.

Ratings on Atlanta-based UPS reflect its very strong position in ground parcel delivery and substantial and consistent earnings and cash flow, offset by a more aggressive stance toward shareholder rewards, which will result in a somewhat more leveraged (albeit still conservative) capital structure. UPS benefits from its position as the leading provider of ground package delivery in the U.S. and from its significant presence in domestic air express package delivery, international package delivery, and logistics services.

UPS has expanded its business position in recent years through acquisitions, the most notable of which include the December, 2004, acquisition of Menlo Worldwide Forwarding, a freight forwarder, and the August, 2005, acquisition of Overnite, a less-than-truckload (LTL) trucking company (now called UPS Freight). With these acquisitions, UPS added heavy-air-freight and trucking capabilities to its portfolio of services, thereby improving its competitive position with customers looking for a broad range of capabilities. Integration challenges depressed the operating performance of these businesses over the past year, but we expect improvement over time.

Impressive Financial Track Record

UPS' market position varies by segment, but generally ranges from dominant to solid. Although there are significant barriers to entry in most of the markets in which it competes, UPS faces formidable competition from a handful of other integrated service providers, as well as from a wide range of companies competing in specific market segments. While competitive pressures surface in specific pockets of the market from time to time, pricing, for the most part, has remained rational over time and dramatic swings in market share are not common.

UPS' financial track record is impressive, historically reflecting strong and consistent earnings and modest debt usage, despite significant costs incurred for international expansion and purchases of new freighter aircraft. With its plans to operate with more debt in the future, financial metrics will deteriorate. Adjusted FFO/debt is expected to average 50% (compared with the over 100% level generated in recent years) and adjusted debt to capital is likely to increase to the mid-to-upper 60% area. (This compares with the low-30% area of recent years.) Current ratings assume credit metrics will remain within the projected bands and that UPS will adjust the level of shareholder rewards and investment spending to maintain metrics in line with Standard & Poor's expectations.

UPS maintains several single-employer defined-benefit pension plans. As of Dec. 31, 2006, these plans were fully funded. However, the company does have a sizable underfunded post-retirement health benefit obligation, which totaled $2.4 billion on Dec. 31, 2006.

Outlook

The outlook is stable. UPS' focus on improving yields, cutting costs, and making more efficient use of capital should help the company sustain its very strong competitive position and maintain a financial profile in line with its new guidelines. A significant increase in pricing pressures or cost pressures over time could lead to a revision of the outlook to negative. We consider an outlook change to positive less likely.

"UPS has had a long-standing commitment to a very strong balance sheet for decades and that will not change," said Scott Davis, UPS's chairman and CEO. "Indeed, we are putting that balance sheet strength to work to more efficiently deploy capital for the benefit of our shareowners. UPS's consistent, stable cash flows mean we can accept a higher degree of debt while continuing to strategically grow our business."

By Standard & Poor's Ratings Services and BW staff