United Parcel Service (UPS) stock took a hit following the company's latest earnings report, despite beating expectations. The culprit behind the decline? Labor costs.

In the third quarter of 2022, UPS reported earnings per share (EPS) of $2.99, a significant drop from the previous year. Furthermore, the company's guidance suggests a fourth-quarter operating profit of around $2.4 billion or $2.5 billion, falling short of Wall Street's estimate of $3 billion.

However, J.P. Morgan analyst Brian Ossenbeck remains unfazed. In a recent report, he stated, "Although UPS cut the 2023 outlook, we don't believe the setup on the stock changed too much."

So why the nonchalant attitude? It all boils down to labor math. The new five-year labor deal with the Teamsters union includes immediate wage increases for workers to keep up with inflation. However, UPS cannot immediately raise prices to cover these costs. CFO Brian Newman explains, "We need $1 of pricing over five years, that's like 20 cents a year, to cover the cost of the contract. But 46% of the wage increases are coming in the first 12 months."

This discrepancy between immediate labor costs and delayed price adjustments has put a strain on margins. It's a challenge exacerbated by the recent high inflation rates. In the past, when wages and inflation both increased at a similar pace, there was no such mismatch.

Investors should take note of this upfront cost dynamic when considering labor deals with other companies, such as those in the auto manufacturing industry.

As of early trading on Friday, UPS stock has declined approximately 17% over the past year. In contrast, the S&P 500 and Dow Jones Industrial Average have seen gains of about 9% and 2% respectively.

Looking ahead, J.P. Morgan's Ossenbeck suggests that UPS will need to show volume growth before he becomes more positive on the stock. With that said, he currently maintains a Hold rating on UPS shares with a price target of $165.

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