united parcel service analyst report · united parcel service analyst report 2016-2017 uconn...

UNITEDPARCELSERVICEANALYSTREPORT

2016-2017UConnStudentManagedFund

StevenGaspariniandJoeCotton

TABLEOFCONTENTS

ReportHighlights...............................................................................................................................1BasisforRecommendation.......................................................................................................................1BusinessDescription...................................................................................................................................1

IndustryOverviewandTrends.....................................................................................................2IndustryOverview........................................................................................................................................2GrowthofE-Commerce...............................................................................................................................2ExpansionofGlobalTrade.........................................................................................................................2ShifttoAutomatedDeliverySystems.....................................................................................................3GreaterFuelEfficiency................................................................................................................................3

InvestmentThesis.............................................................................................................................3Thesis................................................................................................................................................................3E-CommerceandAmazonPartnership.................................................................................................3HealthcareLogistics.....................................................................................................................................4ORION...............................................................................................................................................................5

Financials.............................................................................................................................................5ConsistentRevenueandProfitGrowth..................................................................................................5HealthyFinancialPicture...........................................................................................................................6CommitmenttoMaximizingShareholderReturn..............................................................................6

Valuation...............................................................................................................................................6DiscountedCashFlowModel(50%weight)........................................................................................6DividendDiscountModel(50%weight)...............................................................................................7

RiskstoInvestmentThesis.............................................................................................................7RisingFuelPrices..........................................................................................................................................7EconomicConditions:DomesticandAbroad......................................................................................7ProtectionistTradePolicies......................................................................................................................8

Conclusion............................................................................................................................................8

Appendices..........................................................................................................................................9

ReportHighlights

UnitedParcelService,Inc.(NYSE:UPS)Sector:Industrials

CurrentPrice PriceTarget 52-WeekHigh 52-WeekLow P/E MarketCap. Recommendation

$104.99 $129.47 $120.44 $100.05 27.25x $91.21B Buy

BasisforRecommendaHon

WerecommendaBuyratingforUPSbasedonapricetargetof$129.47pershare,offeringa23.3%marginofsafetyoverthe

closingpriceof$104.99pershareasofApril7,2017.Our

recommendationisprimarilydrivenbythreefactors:

1.Highbarrierstoentrywithintheindustry–UPSmaintainsanindustryleading57%marketshareinthedomesticcourierand

deliveryservicesspaceoveritstwomaincompetitors,FedExand

USPS.

2.Growthofe-commerceandhealthcarelogistics–UPSispositionedtoexperienceincreasedrevenuegrowthfromthesurge

ine-commercebothdomesticallyandinternationally.Likewise,its

recentpushintothehealthcarelogisticsspacethroughacquisitions

willenableittocapitalizefromthegrowingglobalbiopharma

industry.

3.Costefficienttechnologicalcapabilities–UPS’sORIONlogisticstechnologywillcontinuetoreducecosts,increasemargins,

andenlargeitslogisticssolutionsbusinessexposurethroughits

SupplyChainandFreightsegments.

BusinessDescripHon

UPSistheworld’slargestpackagedeliverycompany,aleaderinthe

U.S.less-than-truckloadindustry,andthepremierproviderof

globalsupplychainmanagementsolutions.UPSdeliverspackages

eachbusinessdayfor1.6millionshippingcustomersto8.7million

receiversinover220countriesandterritories.In2016,the

companydeliveredanaverageof19.1millionpackagesperday,or

atotalof4.9billionpackagesthroughouttheyear.Totalrevenuein

2016was$60.9B.Revenuebreakdownbasedonpercentof

revenuein2016isshowninFigure3.UPSalsoservestheglobal

marketforlogisticsservices,whichincludetransportation,

distribution,contractlogistics,groundfreight,oceanfreight,air

freight,customsbrokerage,insurance,andfinancing.

0.00%

20.00%

40.00%

60.00%

80.00%

Jan-13 Jan-14 Jan-15 Jan-16 Jan-17

Figure1:UPSvs.SPYReturn

UPS SPY

Figure2:UPSMarketShare

Figure3:UPSRevenuebySegment

IndustryOverviewandTrends

IndustryOverview

Thedomesticcourieranddeliveryservicesindustryisprimarily

composedofthreemajorfirms:UPS,FedEx,andtheUnitedStates

PostalService(USPS).UPSspecializesinfreightandground

shippingwithafleetof240aircraftand114,000groundvehicles.

FedExspecializesinnext-dayairservicedeliverieswithafleetof

650aircraftand50,000groundvehicles.TheUSPSspecializesin

residentialmailandsmallpackagedeliveryanddonotownanyof

theirownaircraft,choosingtocontractcommercialaircraft.USPS

ownsagroundfleetof211,000vehicles.AsshowninFigure2,UPS

dominatestheindustrywith57%marketsharewithFedEx

securing~25%ofthemarket.SeeFigure4foraUPSandFedEx

comparison.

GrowthofE-Commerce

Thecourierindustryishighlycorrelatedtothee-commerce

industry.From2015-2016,domesticonlineshoppingincreasedby

15.6%from$341Bto$395B(Mintel).Thegrowthinthedomestic

e-commerceindustryisprojectedtocontinuetogrowatanaverage

annualrateof15%toamarketof$600Bby2020.Globale-

commercesalesarepoisedtogrow112%overthenextfouryears

toa$4trillionmarket(Statista).UPShasrecognizedthegrowthin

thisindustryandannouncedthepurchaseof14Boeing747-8

jumbofreightersinQ3of2016tosupplementitsexistingcapacity

foroverseasdelivery.Thecompanyalsooperatesfacilitiesinover

220countriestoaccompanytheincreaseddemand.

ExpansionofGlobalTrade

UPShasbeencommittedtoexpandinginbothdevelopedand

emergingmarkets.Overthenexttenyears,emergingmarketsare

expectedtocontributetomuchofglobalGDPgrowthandan

increasingportionofglobaltrade.Totakeadvantageofthese

opportunities,UPShasmadelong-terminvestmentsinChina,

Poland,andTurkey,withfacilitiesinWarsawandIstanbul,coupled

withairhubsinShanghai,Shenzhen,andHongKong.Theaddition

of14Boeing747-8stoitsfleetwillhelpitservetheemerging

marketsofIndia,LatinAmerica,Africa,EasternEurope,andparts

oftheMiddleEast.UPSplaysanimportantroleinbothglobaland

regionaltradeandiswellpositionedtotakeadvantageoftrade

growth,whereveritoccurs.Thecompany'sglobalpresenceand

productivitybyenhancingtechnologieshavealloweditscustomer

basetoefficientlyexpand,leadingtonewmarketsand

opportunities.

Market

Cap.Revenue

(2016)Net

Income

(2016)

P/E Packages

Delivered

DailyUPS $91.2B $61B $3.4B 27.3x 19.1M

FedEx $52.3B $50B $1.8B 27.7x 3.4M

Figure5:GlobalE-CommerceGrowth

Figure4:UPSandFedExComparison

Figure6:UPSGlobalDeliveryGrowth

The15developedandemerging

marketswe’veprioritizedofferbetween

$80Band$90Binopportunityacrossall

ourbusinessunits.

~UPSCEODavidAbney

ShiRtoAutomatedDeliverySystems

UPShasacknowledgedtheemergenceofautonomousdrivingand

relateddeliverysystems.Eachoftheir2,600Class8deliverytrucks

havealreadybeenequippedwithfullcollisionavoidancesystemsto

alertdriversofobstaclesonallsidesofthevehicle.Likewise,on

February21,2017UPSunveileditsdronepackagedeliverysystem

thatwillbeginaccompanyingallvehiclesinthesummerof2017,

allowingmultiplepackagestobedeliveredsimultaneouslyin

remotelocations(bybothdriveranddrone).

GreaterFuelEfficiency

8,100ofUPS’sdeliveryvehiclesrunonalternativefuelsources,

suchaselectricandnaturalgas.Thecompanyhasalsocreatedan

algorithminitsORION(On-RoadIntegratedOptimizationand

Navigation)systemthatreducestheamountof“right-hand”turnsa

drivermakesoverthecourseofdelivery.Thecompanystatesthat

thistechnologyhassaved10milliongallonsoffuelayearandhas

reducedCO2outputbyover100,000metrictons(theequivalentof

21,000cars).TheseresourcesshowthatUPShasmadeaconscious

efforttoadapttoamoreself-reliantenergytrendandhas

positioneditselftosucceedinanenvironmental-sustainingway.

InvestmentThesis

Thesis

UPSisbestpositionedintheindustrytosucceedfromsignificant

growthinthee-commerceindustrythroughtheirstrategic

partnershipwithAmazonandtechnologicalresources.Likewise,

thecompany’sacquisitionsinthehealthcarelogisticsspaceprovide

significantgrowthopportunitiesinanexpandingindustry.Lastly,

UPS’sfullrolloutoftheirORIONsystemwillincreaseUPS’s

operatingmarginsbyreducingcostsandexpenses.

E-CommerceandAmazonPartnership

Asaforementioned,thetrendofe-commercehasincreasedthe

demandforshippingservicesglobally.UPShasalreadybegunto

capitalizefromanincreasingvolumeinshipping.Business-to-

consumershipments,whichrepresentedmorethan48%oftotal

U.S.DomesticPackagevolumein2016,grewnearly9%fortheyear

and11.5%inthefourthquarter,whichdroveincreasesinbothair

andgroundshipments.Likewise,NextDayAirvolumeincreased

5.2%in2016duetostronggrowthine-commerce.

Figure7:UPSDroneDeliverySystem

Figure8:UPSFuelEfficiencyMetrics

BUY

E-Commerce

Healthcare

Logistics

ORION

Figure9:UPSInvestmentThesis

Figure10:B2CMixExpectedtoClimb

Toaccommodatetheriseinparcelshippingasaresultoftheboom

ine-commerce,UPShasdevelopedtheproperresources.The

companyofferscost-effectivesolutionssuchasUPSSurePost,for

U.S.domesticshipments,andUPSi-parcelforalow-costdeferred

crossbordersolution.Theyalsooffercustomizablesolutions,such

asUPSMyChoice,aservicethatprovidesmorethan32million

memberswithvisibilityandcontroloftheirinboundshipments.

ThescopeofUPSMyChoicehasbeenenhancedoverthepastyear

withtheadditionofUPSFollowMyDeliveryfortime-sensitive

shipments.Thisserviceoffersmap-basedtrackingfromapackage's

deliverydeparturetoaUPSMyChoicemember'sresidence.

UPSMyChoicemembershavetheaddedflexibilitytodirect

packagestoUPSAccessPointlocationswhentheywillnotbehome

toacceptadelivery.UPSAccessPointlocationsareconvenient

places–suchasTheUPSStoreandotherlocalbusinesses–that

offereasypackagedrop-offandpick-up.Witheveningandweekend

hours,UPSAccessPointlocationsbetterfitsomeconsumers’

schedules.Merchantsin50countriesandterritoriescanalready

shipdirectlytoUPSAccessPointlocations,givinginternational

merchantsandconsumersgreatercontroloverpackagedeliveries.

UPS’srelationshipwithe-commercegiantAmazon.com,Inc.hasled

toUPShandlingabout30%ofAmazon’s600millionpackages

withintheUnitedStates(oranestimated$1BinrevenuetoUPSa

year).Thisvolumehasgrown500%overthepast10yearsandis

poisedtocontinuetogrowgiventhegrowthprospectsofboth

Amazonandonlineshopping.

HealthcareLogisHcs

UPShasrecentlybeenpushingintohealthcarelogistics,recognizing

theincreaseddemandforhealthcareservices.Thecontinuous

advancesinmedicine,alongwithanagingworldpopulation,

createsaneedforlogisticspartnerswhocanprovidespecialized

temperature,chain-of-custody,andspeed-in-transitthattoday’s

healthcarecompaniesrequire.Withglobalbiopharmasales

projectedtogrow41%through2020(Figure14),thehealthcare

shippinglogisticsindustryispoisedtodirectlybenefitUPS.In

2016,UPSexpandeditshealthcarecapabilitiesbyacquiring

Marken,aglobalproviderofsupplychainsolutionstothelife

sciencesindustry,primarilyservingtheclinicaltrialslogistics

space.Clinicaltrialsaresubjecttostrictregulatorycompliance

(certifiedbytheFDA),requiretemperature-controlledlogistics

services,andaretypicallyglobalinreach.Markenoperatesaglobal

networkofclinicalsupplychainservicestomeettheincreasingly

complexdemandsofitsclients.TheacquisitiondoublesUPS’s

healthcarededicatedfacilitiestoover100andexpandsits

healthcarelogisticsservicesportfolio.

Figure13:UPSDeliversAmazonParcels

Figure11:GrowthofOnlineRetail

Figure12:UPSMyChoice

Figure14:GlobalBiopharmaSalesTrend

ORION UPScompletedPhase1ofdeploymentofitsOn-RoadIntegrated

OptimizationandNavigation(ORION)systemin2016andplanson

havingitfullyimplementedby2019.ORIONusesexpansivefleet

telematicsandadvancedalgorithmstogatherandcalculate

countlessamountsofdatatoprovideUPSdriverswithoptimized

routes.ThetechnologyhelpsUPSdriverstodeterminetheoptimal

waytodeliverandpick-uppackageswithinasetofstopsdefinedby

starttime,committime,pick-upwindows,andspecialcustomer

needs.

ORIONsavedthecompany$400millionin2016andgenerated

NPVofmorethan$700million.Goingforward,thecompany

expectssavingsof$300-400millionannuallyfromORION’s

implementation,boostingoperatingmarginsandbendingthecost

curve(Figure15).Thereductioninmilesdrivenisalsoexpectedto

cutgreenhousegasemissionsby100,000metrictonsannually.

ORION’stechnologyadvancesalsosupplyUPSwiththeabilityto

efficientlyroutecustomersofitslogisticsbusinesses,givingita

competitiveadvantageoverFedExandotherlogisticspecialist

companies.

Financials

ConsistentRevenueandProfitGrowth

Overall,UPShasmaintainedahealthyfinancialpicture,andwe

expectthisstronggrowthtocontinuegoingforward.UPS’s

revenueshavegrownsteadilyoverthepastfiveyears,whilenet

incomehasremainedrelativelystableonanadjustedbasis.TheU.S.

Domesticsegmentin2016producedsolidrevenuegrowthof4.2%

overtheprioryear,whiletheSupplyChainandFreightsegment

experiencedevenstrongerrevenuegrowthof8.3%YoY.

Meanwhile,robustexportshipmentgrowthof5.1%wasthe

primarycontributortototalInternationaldailyshipmentsrising

4.4%.

Thecompanyexpectsrevenuestoreach$64billionin2017with

hopesofreaching$70billionby2020.Meanwhile,profitsgrew4%

in2016overthepreviousyearduetocostsavingsfromORIONand

top-linerevenuegrowth.Asourinvestmentthesisplaysoutand

UPScontinuestodeliverforcustomers,investorsshouldcontinue

toseestrongrevenueandprofitperformance.

Figure15:UPSCostCurve

Figure16:UPSOperatingMargin

Figure17:UPSRevenueGrowth

Figure18:UPSNetIncome

HealthyFinancialPicture

UPS’searningspictureisstrong,asevidencedbyitsindustry

leadingfinancialratiosandmetrics.UPShasconsistently

outperformeditsmaincompetitor,FedEx,inprofitability.Its8.72%

returnonassetsand238.68%returnonequityfigureshighlight

management’sabilitytoselectprofitableinvestmentopportunities,

suchastheresearchanddevelopmentplacedintotheirORION

system.Meanwhile,operatingandnetprofitmarginsof8.98%and

8.43%,respectively,emphasizethecompany’sfocusonbendingthe

costcurvewhilegrowingrevenues.

CommitmenttoMaximizingShareholderReturn UPShasalonghistoryofsharebuybacksandhasincreasedits

dividendfor16consecutiveyearswitha3-yearannualizedgrowth

rateof8.0%.Currently,itsdividendyieldis3.16%,whichis61%

higherthantheS&P500averagedividendyieldof1.96%.Since

2011,UPShasboughtback$16.2billionworthofshares.In2016,

adjusteddilutedEPSincreased6%to$5.75,anall-timehigh,while

thecompanyreturnedover100%ofnetincometoshareownersby

paying$2.8billionindividendsandrepurchasing$2.7billionin

shares.Therefore,itisevidentthatUPSwillreturnasignificant

amountofcashtoshareholdersinthefuture,whetherthrough

sharerepurchasesordividendincreases.

Valuation

DiscountedCashFlowModel(50%weight)OurDCFassumptionsincludeashort-termrevenuegrowthrateof

3.3%,aterminalfreecashflowgrowthrateof2.5%,andaWACCof

6.0%.WebasedourrevenuegrowthrateontheaverageofUPS’s

growthoverthepast5years,aswellasmanagement’sprojections

forthefuture.Likewise,wefactoredintheanticipatedgrowthofe-

commerceandhealthcarelogistics,andultimatelybelieveour3.3%

growthrateisrelativelyconservative.Theassumed2.5%terminal

growthisreflectiveoftheU.S.long-termGDPgrowthrate.Our

WACCof6.0%wascalculatedusingdataprovidedbyBloomberg,in

additiontotheCapitalAssetPricingModeltoaccuratelyestimate

costofequity.

Wearrivedatapersharevalueof$129.81,whichweweightedat

50%ofourtargetprice.OurfullDCFmodel,includingasensitivity

analysis,canbefoundinAppendixG.

Model Price Weight

DCF $129.81 50%

DDM $129.12 50%

TargetPrice $129.47

CurrentPrice $104.99

MarginofSafety 23.3%

DCFAssumptions ShortTermGrowthRate 3.3%

TerminalGrowthRate 2.5%

WACC 6.0%

Figure20:UPSDividendsPerShare

Figure21:ValuationSummary

Figure19:FinancialMetrics

Figure22:DCFModel

DividendDiscountModel(50%weight)

OurDDMassumptionsincludedthesameterminalgrowthrateof

2.5%,aswellasaWACCof6.0%.Ourfuturedividendspaidgrowth

rateof6.1%wascalculatedasahistoricalaverageratefrom2007-

2015.However,wegraduallywalkedthisnumberdownto5%over

the10-yearprojectedperiodtoreflectthecompany’sexpected

maturation.Wealsoassumedthecompanywouldcontinueits

historicaltrendofrepurchasing2%ofitsshareseachyear.We

arrivedatapersharevalueof$129.12,whichweweightedat50%

ofourtargetprice.OurfullDDMmodel,includingasensitivity

analysis,canbefoundinAppendixH.

RiskstoInvestmentThesis

RisingFuelPricesUPSisexposedtochangesinthepriceofgasoline,diesel,andjet

fuel,astheseenergysourcesfuelUPS’sgroundandairfleets.

Therefore,higherfuelcostscouldadverselyimpactUPS’soperating

results.However,tomitigatetheirexposuretochangingfuelprices,

thecompanyentersintohedgingtransactionstolockincurrentoil

pricesandreducevariability.Withoiltradingnearitslowestprices

inyears,UPShasbeenabletoreduceitscostofoperationsand

employhedgingstrategiestotakeadvantageoftheoilsupplyglut.

However,evenifoilpricesbegintorise,webelieveUPS’seffortsto

transformitsgroundfleetfromonedependentongasolineand

dieseltoafleetthatismorereliantonalternativeenergysources

willhelplessentheimpactofrisingprices.

EconomicCondiHons:DomesHcandAbroad

UPSconductsoperationsinover220countriesandterritories.Its

U.S.andinternationaloperationsaresubjecttonormalbusiness

cyclesaffectingtheeconomyingeneral.Sincethefactorsthat

createcyclicalchangestotheeconomyandtoUPS’sbusinessare

beyonditscontrol,itmaybedifficulttomitigatetheimpactofthese

factors.Inparticular,UPS’sbusinessisaffectedbylevelsof

industrialproduction,consumerspending,andretailactivity.

Internationally,theUnitedKingdom’svotetoleavetheEuropean

Unioncouldalsoresultineconomicuncertaintyandinstability,

resultinginfewergoodsbeingtransportedglobally.However,we

believethatthecurrentTrumpadministration’spro-growth

policies,particularlythosefocusedonincreasedinfrastructure

spendingandtaxcutswillallowUPStotransportgoodsmore

efficiently,aswellasboostdomesticGDPandconsumerspending.

DDMAssumptions

TerminalGrowthRate 2.5%

WACC 6.0%

DividendGrowthRate 6.1%-5.0%

ShareRepurchaseRate 2.0%

Figure23:DDMModel

Figure24:OilPricesSince2012

Figure25:GDPGrowthSince2006

ProtecHonistTradePoliciesUPScurrentlyderives21%ofitsrevenuesfrominternationalmarketsandhasmadelongterminvestmentsto

accommodatethegrowthinthesemarkets,suchaspackagesortingfacilitiesandincreasingitsairfleet.Thus,

freeglobaltradeisvitaltoUPS’sbusiness.Withthepotentialforprotectionisttradepoliciesdomesticallyand

globally(Brexit),UPSmayfaceanincreasedcostintransportingcross-border.However,UPSstilloperatesmainly

intheUnitedStates(whichcomprises79%ofitsrevenues)andmaintainsageographicaldiversityofits

internationaloperationstoensurethatthecompanyisnotoverlyreliantonasingleforeignregionorcountry.

Conclusion

Inconclusion,wereiterateourBuy ratingofUPSwithapricetargetof$129.47pershare,whichprovidesa23.3%marginofsafetyover

itscurrentpriceof$104.99.UPSispoisedtoprovideastrong

returnforinvestorsoverthenext10yearsduetoitsleading

positionintheparceldeliveryandcourierindustry,whichithopes

togrowgiventhecompany’slong-terminvestmentsmadeabroad.

Likewise,webelievee-commerceandhealthcarelogisticsprovide

UPSwithmanyopportunitiestogrowrevenuesandcapitalizeon

shiftsdrivenbytechnology.Lastly,UPS’sabilitytorecognize

changesindeliveryautomationandfuelindependencebyinvesting

inautonomoustransporttechnologies,drones,andalternativefuel

vehicleshaspositionedthecompanytosucceedintothe

foreseeablefuture.

Figure26:UPSGlobalFootprint

Appendices

AppendixA:UPSQuickFacts

AppendixB:InternationalShippingTrend-UPSvs.FedEx

AppendixC:UPSManagement

AppendixD:UPSBoardofDirectors

AppendixE:UPSRevenueMetrics

AppendixF:UPSFinancialProjections

AppendixG:DiscountedCashFlowModel(50%weight)

AppendixH:DividendDiscountModel(50%weight)

WACC

Grow

thRate

AppendixI:IncomeStatement

AppendixJ:BalanceSheet

AppendixK:StatementofCashFlows

AppendixL:Sources

UPS10-K,UPSInvestorRelations

UPS2016Presentation,UPSInvestorRelations

FedEx10-K,FedExInvestorRelations

OnlineandMobileShopping,Mintel

CourierandLocalDeliveryServicesintheUS,IBISWorld

UPSUsesDronestoDeliverPackages,WallStreetJournal

PharmaceuticalColdChainLogistics,PharmaceuticalCommerceandIMSHealth

ValueLineInvestmentSurvey

Morningstar

Bloomberg

Statista

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