S&P Lowers Outlook on UPS (UPS) to Negative; Ratings Affirmed

August 8, 2016 2:56 PM EDT

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Key points:

  • United Parcel Service Inc.'s (UPS) adjusted credit metrics remain weaker than we had previously expected, primarily due to the company's substantial pension deficit, which we treat as debt.
  • Although we expect the company's earnings and cash flow to improve from the growth of its e-commerce business and management's cost-reduction initiatives, we don't anticipate that UPS' pension deficit will decline materially through 2017 because we expect that interest rates will remain low over this period.
  • Therefore, we are revising our outlook on UPS to negative from stable and are affirming all of our ratings on the company.
  • The negative outlook reflects our expectation that the company's funds from operations (FFO)-to-debt ratio will remain consistently in the high-30% area through 2017, which compares with our previous expectation of 40%-55%. If we come to expect that UPS' FFO-to-debt will fall below the high-30% area for a sustained period, we could downgrade the company.

S&P Global Ratings said that it has revised its outlook on United Parcel Service Inc. (NYSE: UPS) to negative from stable.

At the same time, we affirmed all of our ratings on the company, including our 'A+' long-term corporate credit rating.

"The outlook revision on UPS reflects our belief that the company's credit metrics will continue to be weaker than we had previously expected," said S&P Global credit analyst Betsy Snyder. Originally, we had anticipated that the company would maintain an FFO-to-debt ratio of 40%-55%. However, due to its growing pension deficit (which we treat as debt in our adjusted credit metrics) UPS' FFO-to-debt ratio has declined to--and remained within--the high-30% area since 2013. As our economists currently predict that U.S. interest rates will only moderately increase through 2017, we now expect the company's FFO-to-debt ratio to remain relatively consistent over that period. This metric excludes UPS' exposure to multiemployer pension plans (MEPP; though we do factor it into our analysis) because that information is provided to us on a confidential basis.

The negative outlook on UPS reflects our expectation that the company's earnings and cash flow will improve due to the growth of e-commerce and management's operating efficiency programs. However, we also expect that continued low interest rates will cause UPS to maintain the substantial pension deficit under its own plans and the multi-employer pension (MEPP) plans in which it participates. Therefore, we don't expect that the company's adjusted credit metrics will improve and anticipate that its FFO-to-debt ratio (before adjusting for the MEPP plans) will remain in the high-30% area through 2017.

As part of our expectation that UPS' FFO-to-debt ratio will remain in the high-30% area, we assume that the company will remain disciplined in its cash flow allocation over the next 18—24 months. However, if more aggressive shareholder rewards or investment activity or unexpected operating challenges lead us to believe that the company's FFO-to-debt will fall below the high-30% area, we could lower our ratings.

We could revise our outlook on UPS to stable over the next 18-24 months if we believe that its FFO-to-debt ratio will average at least 40% due to a better-than-expected operating performance, a greater-than-expected increase in interest rates, or if management decides to pursue a more conservative financial policy.

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