United Parcel Service Inc. (NYSE: UPS) remains well positioned to benefit from a number of positive trends, including the continued growth of e-commerce. UPS provides shipping, logistics and return services for internet retailers, whose sales are growing three- to four-times faster than those of brick-and-mortar stores. After several years of streamlining, we believe that UPS is poised to leverage solid volume growth in the U.S. domestic market. We are also encouraged by the company’s CEO transition, as a well-respected executive from Home Depot has now taken over at UPS.
The beta on UPS is 1.00.
The company reported 3Q earnings that were up 10% year-over-year and well above analyst expectations. Adjusted operating income increased 10%, though the operating margin narrowed by 70 basis points to 11.3%. Adjusted EPS came to $2.24. The consensus had called for $1.86.
EARNINGS & GROWTH ANALYSIS
UPS has three primary segments: U.S. Domestic Package (62% of sales); International (19%); and Supply Chain and Freight (19%).
In the U.S. Domestic Package segment, revenue rose 15%, driven by a 14% increase in average daily volume. Demand for residential delivery remained strong. Management commented that it sees opportunities to reduce costs in this segment in future quarters.
Revenue in the International segment increased 17% year-over-year, up from 6% growth in the prior quarter. Average daily volume grew 12%, driven by strong outbound demand from Asia. The adjusted operating margin was 23.8%, up 400 basis points from the prior year.
LTL efficiency improved, while truckload brokerage faced excess capacity and lower demand; air freight led the segment, driven by a surge in Asia.
FINANCIAL STRENGTH & DIVIDEND
Adjusted free cash flow was $5.9 billion through 3Q20. The company has cash on the balance sheet of $8.8 billion, a $2 billion syndicated credit facility that expires December 2020, and a $2.5 billion facility that expires December 2023. Both credit facilities are undrawn.
UPS pays a dividend. In 1Q20, the company boosted its quarterly payout by 5.2% to $1.01 per share, or $4.04 annually. For more than four decades, UPS has either increased or maintained its dividend. Since 2000, the dividend has more than quadrupled.
UPS has a share buyback program, though it has suspended buybacks for 2020.
MANAGEMENT & RISKS
UPS is undergoing a CEO transition. Ms. Tome is the former CFO of Home Depot, and has also been a member of the UPS board and chair of the audit committee. Brian Newman was previously a senior executive at PepsiCo.
The company continues to innovate, and we expect innovations to accelerate under Ms. Tome. In her first earnings report with UPS, she stated that the company has five core principles underpinning its actions:
— UPS’ values
— The dividend
— A strong investment-grade credit rating
— Brand relevance
— Employee ownership.
Everything else is up for review, she said.
The company attempts to drive growth through innovation. In July 2019, before CEO Tome came on board, the company announced several new products and services, including a customized offering for business customers; increased investment in the U.S. network to speed transit times; extended-hours pickup for next-day ground delivery; a seven-day delivery network, beginning January 1, 2020; new partnerships with leading retailers, including CVS and Advance Auto Parts; and a new drone subsidiary, UPS Flight Forward.
Investors in UPS face numerous risks. These include uneven economic growth in both the U.S. and in international markets, labor negotiations, and even exposure to the struggling U.S. Postal Service. In recent years, overcapacity in the air freight market has put pressure on yields across the industry. And UPS customer Amazon.com (AMZN: BUY) is taking steps to deliver more packages on its own, though we note that the UPS fleet of more than 250 planes provides a strong competitive advantage.
UPS also has pension plan risk. The company is addressing this risk by transitioning to a 401(k) plan in 2023.
UPS also faces political risks, as the Trump administration works to revise international trade agreements. If the administration dismantles or scales back existing trade deals, or fails to pass new agreements, UPS’s results could suffer.
The world’s largest package-delivery company, United Parcel Service (UPS) provides a wide range of transportation, distribution and logistics services. The company has three main business segments: U.S. Domestic; International; and Supply Chain & Freight.
Compared to peers, the stock’s valuation multiples are mixed, but generally below industry averages. Our dividend discount model renders a fair value north of $180 per share.