Summary
- UPS is set to increase profitability on margin growth despite reduced volume from an increasingly challenging macro environment.
- Negotiations with the Teamsters will be challenging but should be able to be accommodated. The contract is up in July.
- UPS technology will help maintain margins, notwithstanding higher labor and operating costs.
- There is substantial running room for UPS to enhance the value of its services and its stock value.
New York (February 1) - UPS released earnings yesterday with these highlights:
Full-Year 2022 Consolidated Results
- Revenue increased 3.1% to $100.3 billion.
- Operating profit of $13.1 billion; adjusted operating profit of $13.9 billion, up 5.4%.
- Operating margin was 13.0%; adjusted operating margin was 13.8%.Diluted EPS totaled $13.20; adjusted diluted EPS were $12.94.
- Adjusted return on invested capital was 31.3%.
- Cash from operations was $14.1 billion and free cash flow was $9.0 billion
- Diluted EPS of $3.96 in Q4; Adjusted Diluted EPS Up 0.8% Over Last Year to $3.62
- Quarterly Dividend of $1.62, a Per Share Increase of 6.6%, and Authorizes a New $5B Share Repurchase Program, Replacing the Existing Authorization
In addition, the Company returned $8.6 billion of cash to shareowners through dividends and share buybacks.
- From the UPS press release .
In the conference call Tuesday morning, CEO Carol B. Tomé discussed 2022Q4 and said revenue was $27 billion, down 2.7% from the same quarter last year. Operating profit was $3.8 billion, down 3.3%. The consolidated operating margin declined 10bps from last year to 14.1%; however, US adjusted operating margins expanded to 12.8%. For the year, Ms. Tomé said UPS missed its consolidated revenue target by about 2%; however, nearly all of that was attributable to a stronger than anticipated dollar reducing foreign earnings upon translations.
She also praised DAP, the application program interface, or API, run by EasyPost , a company which says of itself that it "solves complex logistics problems for online merchants, enabling the delivery of an online shopping experience that delights customers." Ms. Tomé said it added $2.3 billion to UPS revenue in 2022. She also highlighted UPS Deal Manager, an enhanced technology that allowed UPS to onboard new SMB customers.
Ms. Tome chose not to discuss the upcoming contract with the Teamsters, which is up in July, holding her cards until negotiations begin in April, but in response to analyst's question, she did relate that UPS and UPS are not far apart. She also indicated that UPS was addressing the problems with heat in summer months. "We've already kicked off a total revamp of our safety program, bringing in new technology, hydration, cooling systems, and a whole lot more to address heat," she said.
Analysis
UPS is, in our view, best in class in the package delivery business. We wrote favorably of it last October. It also has added value potential in its UPS Healthcare, particularly its cold chain shipping , essential to insulin and other medications and its LaaS (Logistics as a Service) platform announced last quarter.
Those two business segments may very likely deliver higher returns on invested capital than the basic UPS core package transport and delivery business. We would like to see them reported as separate business segments going forward as UPS may one day wish to spin them off to shareholders while retaining operating relationships with the basic UPS business.
We're also happy to see Tomé pursuing "six sigma perfection", as she said in the call, even if she really doesn't understand it. (Sorry, Ms. Tomé, while 1 misload in 1,000 is certainly an improvement, it's not "Six Sigma (6perfection". That would be 3.4 misloads per million.)
That said, some of the growth we see and foresee in UPS has considerable challenges.
Downside Challenges
First, the negotiations with the Teamsters are likely not as close as Ms. Tomé assumes. Bloomberg says the negotiations "are likely to be the most contentious talks since UPS workers were on strike for 15 days in 1997". The Teamsters also want to eliminate the two-tier wage system. UPS will also have to cede the air conditioning issue, at least on new vehicles, so it will result in higher capex for new trucks and higher fuel costs from running the AC. There also seems to be some pushback on the UPS "Total Service Plan" in the unofficial employee message board.
Second, UPS has no moat in its digital appeal to SMBs. EasyPost, the UPS platform for onboarding SMB customers, is a VC/PE -owned company and not publicly held. But any shipping company can access it and several competitors do. Moreover, there are similar platforms like ShipMonk ( headquartered in Florida); Hive (Germany), and a few others. Paack (Spain), etc. and several others are in the "last mile"/same day shipping tech space and could expand. Seeking a competitive advantage with non-exclusive technology is inherently risky (see, e.g., IBM's non-exclusive license of Microsoft's original DOS software that undercut the IBM-PC market by flooding it with "clones".).
Third, Amazon (AMZN), as a competitor, has made merchandise returns ridiculously easy, including label-free, box-free, returns, as detailed on the Amazon website.
How to complete a label-free, box-free return
Select a label-free, box-free return location after initiating your return through Your Orders. After completing the steps, you'll receive a QR code. Bring it to the drop off location with the item you want to return. You don't have to package your item in a shipping box.
This should be an easy match by UPS, given that they pack goods at their stores. But UPS needs to take up the competitive challenge, especially for its SMB businesses.
Upside Potential from Enhancements
There are three things that could substantially enhance UPS stock value and service value added. In order of preference, they are
First, UPS should target EasyPost for acquisition. While there are other platforms, having a captive platform, together with UPS other best-in-class attributes will add substantial value to the stock and the service offerings. It also creates to "moat" mentioned above.
Second, UPS should host a digital B2B and B2C webpage for its customers/clients, akin to the one offered by Alibaba. One of the toughest challenges for SMB is finding a platform. Integrating their websites into a UPS platform with UPS shipping and other services, and collecting a fee for items sold through the UPS topside platform would enhance customer service and stock value.
Third, as a company with hundreds of thousands of working people and middle-income managers, who seem incredibly loyal to the company. Splitting the stock so that it sells for $40 or $50 would create additional demand for the shares from UPS workers, family members, friends, and other small retail investors to buy odd blocks. Couple it with the UPS DRIP (dividend reinvestment program), and it not only creates additional share demand but some additional savings opportunities for employees. (Although workers should only put a small part of their savings in their employer's stock.)
Investment Thesis
We anticipate a mild to moderate recession between now and the third quarter, so UPS will continue to have macroeconomic challenges beyond its control.
For the time being, we put UPS at "hold". If Tomé can successfully conclude the Teamsters contract and integrate the higher wage and capex costs we anticipate will come with the new contract without a meaningful negative impact on EBITDA, something we won't see until, likely, the first quarter of 2024, we would rate it a buy and, for investors, dollar cost averaging.
But by the second quarter of 2024, we think shares should be in the $200 / $210 range. If Tomé can integrate the enhancements we've outlined, we see the stock being a very strong buy; essentially an online retailer akin to an Alibaba (BABA) or Walmart (WMT).
If the enhancements we suggest were to occur and be successfully integrated, we see the shares at $250 by the end of 2024. But as described in our note, below, we think that unlikely.
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NOTE: Our commentaries most often tend to be event-driven. They are mostly written from a public policy, economic, or political/geopolitical perspective. Some are written from a management consulting perspective for companies that we believe to be underperforming and include strategies that we would recommend were the companies our clients. Others discuss new management strategies we believe will fail. This approach lends special value to contrarian investors to uncover potential opportunities in companies that are otherwise in a downturn. (Opinions with respect to such companies here, however, assume the company will not change).
For further details see:
UPS Has Enormous Potential But Must Act Further To Fully Realize It