Two top bond rating agencies have lowered their ratings on the unsecured debt of UPS Inc. (NYSE:UPS), saying the transport and logistics giant may struggle to generate the needed cash to fund sizable capital investments, pension fund obligations, share buybacks and dividend increases without straining its balance sheet.
On August 9, Moody’s Investors Service downgraded UPS debt to A2 from A1 with a negative outlook, while S&P Global lowered its rating to A from A+ with a stable outlook. In a note, Moody’s Senior Vice-President Jonathan Root said UPS’ free cash flow levels will be pressured through 2020 as the company spends more than in prior years to meet the shifts in shipping and logistics patterns triggered by surging e-commerce demand. The capital investment will make it difficult for UPS to fund billions in pension contributions out of internal cash flow, and will increase its reliance on the capital markets to finance the cost of the obligations, Root said.
Indeed, UPS went to the corporate bond market on August 13 to sell $1.5 billion in bonds at three different maturities, Reuters said, citing information from Moody’s.
An aggressive share repurchase program – which has since been throttled back – and annual dividend increases have placed added strains on free cash flows, Root said. The company is also vulnerable to a slowing in shipper demand due to geopolitical events, he added.
In its note, S&P Global advised UPS against “aggressive shareholder rewards” and investments that could worsen the ratio of debt to funds from operations. The agency’s stable outlook was due to evidence of UPS’ strong earnings growth, it said. UPS recently reported solid second-quarter results, fueled in part by an eye-popping 30 percent year-over-year increase in domestic next-day air volumes.
S&P Global said it expects UPS to remain disciplined in its capital allocation, and noted its improvements in operating efficiencies even as it cautioned against higher debt levels from fulfilling its pension obligations.
Moody’s wasn’t as tolerant. “The negative outlook reflects what we believe will remain a challenging operating environment and the compounding effect of prospective material pension funding needs” that will call for more externally generated financing even if share repurchases are further tempered, Root said.
UPS has historically directed all its free cash flow to share repurchases, leaving no cushion for “significant discretionary contributions to its single-employer pension plans,” according to Root.
In a statement, Steve Gaut, a UPS spokesman, said the company “does not expect any impact on our access to the short- and long-term debt markets, nor market pricing.” Gaut added that UPS’ “credit profile today is strong, and is expected to remain strong, consistent with high Investment Grade ratings.”
UPS, which employs more than 250,000 members of the Teamsters union, in 2007 paid the Teamsters more than $6 billion to exit its Central States pension plan, which for decades has funded pension payments to workers at many companies besides UPS. Central States has been in deep financial trouble for years, and there have been multiple efforts to get Congress to reorganize the plan’s finances before it becomes insolvent.