That's not a bad place to start getting to know UPS, but before getting around to justifying UPS's valuation (it currently trades at more than double the enterprise value/EBITDA of FedEx), it's worth taking a little look at some of what UPS is aside from the whole Internet story.
UPS is a steadily growing giant in the package delivery business, operating in more than 200 countries in North America, Asia, Europe, and Latin America. Both its air service and ground delivery system are noted throughout the industry for their innovation, efficiency, and effectiveness.
UPS has a combination that many, if not all, investors love -- a smooth and steadily growing top line combined with dramatically improving margins. Revenues are up to over $27 billion this year from a level of less than $20 billion in 1994, but, more importantly, operating margin has virtually doubled in the same time period -- currently residing at 14.6% up from 7.9% in 1994. Analysts expect margins to continue to improve over the next couple of years, with Merrill Lynch projecting operating margins to be about 15.9% by 2001.
At approximately 9-10% a year, the sales growth rate of UPS is not of the variety that typically gets New Era investors' heart's pounding too quickly, but that's OK -- the growth is pretty steady and predictable in a time where predictability is not all that easy to find. The growth rate is also improving of late, which isn't all that common to find in companies that do $27 billion a year in sales. Because of the increase in e-commerce as a component of Christmas sales, UPS's revenue growth rate for the quarter just ended was estimated to be above 11%, and will almost certainly "surprise" to the upside of that -- as estimates for e-commerce sales seem to have been quite conservative.
UPS has fantastic returns on capital, averaging 22% and improving, and is relatively conservatively funded, with a long-term debt-to-equity ratio of 0.7. Given the opportunity for UPS to expand both domestically -- it is taking market share away from competitors Airborne Freight <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ABF)") else Response.Write("(NYSE: ABF)") end if %> and FedEx parent FDX <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: FDX)") else Response.Write("(NYSE: FDX)") end if %> -- and internationally -- international sales comprise only 13% of the company's revenue -- pouring more capital into the business seems a given.
So with all of this good news lying around, I expect Rick to focus his attack on UPS the stock rather than on UPS the business. Oh, he might lob in some grenade about the strike a couple of years back, and if he does I'll just trot out the fact that the rank and file are quite a bit less likely to go on strike now that there's a share price to be concerned about (a huge percentage of UPS employees are shareholders). No, really, it's the current valuation that is the sole area that would give an investor any pause.
At about 30x this year's expected earnings, and annual earnings growth of somewhere between 12% and 15%, shares of UPS are not "cheap" on traditional price-to-earnings-to-growth models. I'm not really a big believer in those models, however, as they don't really tell you what the risk on an investment is, or how the growth is funded.
In UPS's case, the growth is being funded by free cash flow, which makes for a substantially more worthwhile investment than a company that is cranking out more shares or more debt all the time to keep up its growth. UPS share count is lower today than it was back in 1994, and it is projected that the company is poised to repurchase additional shares from its employees this year. So I'm quite bullish on a company that has a demonstrated history of concrete growth through operations and high return on investments, rather than growth through acquisitions or issuing new debt or equity.
Given the length of history of the operations and the consistency and nature of the growth, I think that running UPS through virtually any sort of a discounted cash flow model is going to produce an intrinsic value for the shares that is higher than today's price, as long as you assume that earnings growth can approximate 12% a year.
So, contrary to what Rick may argue, you really don't need to adopt pie-in-the-sky, Internet-changes-everything approaches to find UPS to be a good investment at today's price. The burden is on Rick to show that the past is not a prelude to the future for this company, and I'm interested to see how he goes about making that argument.
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