| 2009 | 2010 | ||||||
| Price: | 49.04 | EPS | $2.33 | $2.91 | |||
| Shares Out. (in M): | 995 | P/E | 21.0x | 16.9x | |||
| Market Cap (in $M): | 48,797 | P/FCF | 14.0x | 12.0x | |||
| Net Debt (in $M): | 8,345 | EBIT | 3,922 | 4,569 | |||
| TEV (in $M): | 60,373 | TEV/EBIT | 15.4x | 13.2x | |||
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Executive Summary
UPS possesses a genuinely sustainable competitive advantage with growth prospects due to economies of scale in small package collection, processing and delivery. A dominant (50%+) market share in US Ground, which took a century to build and is the largest source of current profits, ensures industry-leading profitability (26% pre-tax ROC, 1999-2008), and sustains the long push to dominate the fast growing international market. In another century’s time, if the company executes well, US Ground should be a bit bigger in real terms, but will be dwarfed by a much larger international business. The value of the economies of scale currently being built in the international business is simply not visible from today’s earnings, because economies of scale are costly to build, but very profitable after completion. The current market price is rare historically, valuing the business at 6.7x-10.1x normalized EBIT, and is attractive given formidable barriers to entry, predictable business model and long term growth prospects.
What I do not attempt to cover in this write-up
This is unashamedly a 50,000 ft write-up. The trouble with flying at altitude is that sometimes you end up over the wrong continent. If so, I am sure that resident experts will put me right, and exchanges during Q&A should prove useful to all. I try to focus my comments on what the company will look like 5 years and beyond. Items central to smaller company write-ups such as detailed business description and earnings projections for the next few quarters are omitted simply because they are much better found elsewhere.
“UPS is efficiently priced by the market, why bother writing it up on VIC?”
1. The current price is in the lowest 3 percentile of all trading activity since the November 1999 IPO.
The daily valuation applied by Mr. Market to this business in the 2,426 days during which he has been on the job (since IPO) has been absolutely higher than his current quote on all but 66 days. Why should a fundamental investor care? Intuitively one might expect that the market valuation for this company to be fairly accurate, i.e. quite close to intrinsic value. It is a large cap stock, commanding plenty of analyst attention, with a familiar and understandable business model. Empirical evidence supports this hunch, with daily market valuation data since 1999 producing low 13% average variation*(notes at bottom) around a long-term average valuation of $66.04 per share (mean, $66.85 median). 81% of daily valuations over the past decade have valued the business at $55-77 per share. So what’s changed? Either in years to come the current valuation will be shown to have been a rare outlier, reflecting excessive pessimism about the company’s prospects, or alternatively, intrinsic value has indeed been permanently impaired. I disagree with the latter, presumed consensus view. I think that the risks and LT outlook for UPS are no worse than in recent years, indeed there are selective reasons to be more optimistic about the future.
2. A diversified toll road model should result in lower than average business risk, which should be highly valued over the next few years.
Volatility of all sorts of fundamental drivers of business profits across the globe is elevated (e.g. government spending, monetary policy, prices), and appears likely to continue for at least the next few years. Boring businesses with dominant market shares, pricing power and growth within their franchises should be highly prized if uncertainty elsewhere continues.
3. (Humour me on this one). UPS will likely benefit from, and therefore could be a partial hedge against, relentless technological change in the long term.
Nowadays I often seem to be assessing the vulnerability to technological change of businesses that I would previously have considered impervious to technological threats (e.g. what price car insurance in 2025 when most cars might be self-driving with built-in accident avoidance technology? Could the value of this traditionally stable business with non-discretionary demand decay to almost nothing?) Regardless of whether you find technology interesting or not, the disruptive impact its continuing progress will have on many business models seems set to accelerate over the next few decades. Potential impacts on business models range from the mundane to the zany. Mundane impacts could be a gradual but significant shift from traditional retailing to e-commerce, removing many retailing “middle-men” and connecting producers direct with consumers linked by frequent home delivery networks (typified by the recent launch of Alice.com, which delivers home essentials direct to consumers, removing the need for store trips; UPS is the chosen shipper). There is precedence in UPS’ history of benefiting from such shifts in retailing. The company originally built its economies of scale around outsourced deliveries from department stores, for example in 1930’s Manhattan (incidentally, the company actually grew during the last Great Depression, increasing total employees threefold 1930-34). Then, shoppers also migrated from shopping in multiple locations to a new central one (then Department Stores, now the internet), and delivery naturally migrated to the most efficient distribution system: UPS. Zany technology developments might also be well hedged through a diversified shipper of “stuff”. What time sensitive small packages might be common in 2025, 2050? Ever smaller, urgent machinery components; human and animal transplant materials; genetically modified seeds and plant matter; chemical and biological components for energy production; high tech consumer goods; the mind boggles at the possibilities. To cynics who doubt if UPS is really a good business to profit from such technological developments, consider how easy it would have been to completely miss the future opportunities and instead focus on the near term threats when what was originally a messenger service (delivering and picking up messages) in 1907 Seattle faced the revolution of commercially available telephones. Just as progressive message technology in the 20th century crushed the traditional demand for the UPS product but replaced it with even higher volumes of small packages, as trade and commerce was stimulated by new technology, so the huge technological advances inevitable for the 21st century should produce ample opportunities for the dominant small package deliverer to grow its business. To take an illustration from another industry, I recall the prophetic observation in the depths of the obesity funk that plummeted fast foods stocks earlier this decade, (I forget the source, maybe it was Ronald Mc Donald himself as we both stared with a sense of foreboding at our super size fries) that while we might not know what fast food would be popular in ten year’s time, it was highly probable that McDonald’s would be selling it. Sure enough today we enjoy chopped carrots with our happy meals and Italian espresso after burgers, and McDonald’s has not just survived but prospered. Similarly I don’t know what kinds of time sensitive small packages we will be wanting to send around the world in 15 years time, but I do know that UPS will be delivering a large proportion of them, and I also suspect that total package volume is likely to increase, not decrease, as the world grows in population, wealth, and productivity.
Valuation. Normalized earnings
For a well-analyzed company with plenty of comprehensive earnings projections available off VIC, I simply summarize some sensible LT ranges for where I think normalized pre-tax operating earnings should fall:
1. No growth: simple trailing LT average, ignoring unit volume growth and pricing
Past 5 years (2004-2008) average: $6.0 billion
Past 10 years (1999-2008) average: $5.1 billion
(excludes 2007 $6.1 billion once-off pension contribution)
2. Normal margins: apply LT average operating margins to 2008 sales
1996-2008 average operating margin: 11.7% (vs. 10.5% actual in 2008)
2008 sales: $51.5 billion
normalized operating earnings: $6.0 billion
3. Wisdom of crowds approach
Operating Profit Forecast: Street Consensus, $ millions (source: Bloomberg):
| FY | 21 March 2008 | 2 July 2009 |
| 2010 | 8,410 | 4,817 |
| 2011 | 9,317 | 5,670 |
| 2012 | 9,874 | 5,782 |
| 1999-2008 | UPS | FDX | DPW.GR | USPS |
| United Parcel Service | FedEx Corp | Deutsche Post AG | US Postal Service | |
| Pre-tax ROC average | 26.2% | 19.6% | 12.3% | Negative |
| Pre-tax ROC minimum |
21.6% | 13.2% | (4.6%) | Negative |
| Operating Margin average | 12.3% | 7.4% | 5.0% | (0.1%) |
| Operating Margin minimum |
10.5% | 5.5% | 0.3% | (6.9%) |
| 1994: U.S. Government Accountability Office (GAO) estimated market shares for domestic expedited, deferred and parcel delivery: | |
| UPS | 54% |
| FDX | 20% |
| USPS | 15% |
| DHL and others | 11% |
| 2009: Morgan Stanley, Shipper Survey: Ground market shares (recognises that USPS is under-represented by customer sample): | |
| UPS | 59% |
| FDX | 36% |
| USPS | 2% |
| others | 3% |
Economies of scale represent an ongoing barrier to entry. Smaller players have dropped out or been swallowed up over recent decades, unable to compete with dominant incumbents. DHL’s 2009 exit from the US express market (with an exit cost of $4 billion) is the most recent evidence of the strength of UPS’ position.
3. Pricing power will therefore be sustained.
Consider the following track record of disclosed annual pricing decisions by the company, by segment (annual percentage rate changes):
| Percentage change, %: | Core PCE price index, yoy (Dec) | Ground commercial | Ground residential premium over commercial | Next Day Air | Deferred | International: US Origin | International: non-US origin |
| 1997 | 1.8 | 3.4 | 2.6 | Not disclosed | |||
| 1998 | 1.4 | 3.6 | 25.0 | 3.3 | 0 | Not disclosed | |
| 1999 | 1.5 | 2.5 | 0 | 2.5 | (2.2) | 0 | Not disclosed |
| 2000 | 1.5 | 3.1 | 0 | 3.5 | 3.5 | 2.9 | Not disclosed |
| 2001 | 1.5 | 3.1 | 5.0 | 3.7 | 3.7 | 2.9 | Not disclosed |
| 2002 | 2.2 | 3.5 | 4.8 | 4.0 | 4.0 | 3.9 | Not disclosed |
| 2003 | 1.6 | 3.9 | 4.5 | 3.4 | 4.5 | 3.9 | Not disclosed |
| 2004 | 1.5 | 1.9 | 21.7 | 2.9 | 2.9 | 3.5 | Not disclosed |
| 2005 | 2.2 | 2.9 | 7.1 | 2.9 | 2.9 | 2.9 | Not disclosed |
| 2006 | 2.2 | 3.9 | 16.7 | 5.5 | 5.5 | 5.5 | Not disclosed |
| 2007 | 2.2 | 4.9 | 2.9 | 6.9 | 6.9 | 6.9 | Not disclosed |
| 2008 | 2.3 | 4.9 | 5.6 | 6.9 | 6.9 | 6.9 | Not disclosed |
| 2009 | 1.8 | 5.9 | 5.3 | 6.9 | 6.9 | 6.9 | Not disclosed |
| % of total 2008 sales | 42% | 13% | 6% | 21% | |||
| Source: Company Filings, Bureaus of Economic Analysis | |||||||
Over the past 13 years, UPS has proven able to consistently raise prices to exceed inflation across businesses. Despite some violent ups and downs during the period in factors such as aggregate demand and fuel prices, the business’ pricing power has remained in tact. Given the current wide debate on the inflationary/deflationary outlook, and the degree of uncertainty on other macro variables with significant business impact (interest rates, tax rates, fuel prices) this pricing power should be very valuable over the next several years.
To demonstrate the significance of UPS’ overall pricing track record, compare UPS Ground Commercial rate increases to those set by a true legal monopoly, the United States Postal Service for First Class Mail:
| % | Core PCE Price Index YOY change (December) | UPS Ground commercial price changes | USPS First Class Mail price changes |
| 1997 | 1.8 | 3.4 | 0 |
| 1998 | 1.4 | 3.6 | 0 |
|
1999 |
1.5 | 2.5 | 3.7 |
| 2000 | 1.5 | 3.1 | 0 |
| 2001 | 1.5 | 3.1 | 12.1 |
| 2002 | 2.2 | 3.5 | 0 |
| 2003 | 1.6 | 3.9 | 0 |
| 2004 | 1.5 | 1.9 | 0 |
| 2005 | 2.2 | 2.9 | 0 |
| 2006 | 2.2 | 3.9 | 3.5 |
| 2007 | 2.2 | 4.9 | 3.6 |
| 2008 | 2.3 | 4.9 | 3.5 |
| 2009 | 1.8 | 5.9 | 3.6 |
| Cumulative | 26.4 | 59.3 | 33.6 |
| CAGR | 1.8 | 3.6 | 2.3 |
The USPS operates various monopolies, many descending from 17th Century English Postal Laws which aimed to foster a single, cheap provider of national mail delivery. Currently in the US, “a letter may be carried out of the mails when the amount paid is at least the amount equal to 6 times the rate then currently charged for the 1st ounce of a single-piece first class letter” (Postal Regulatory Commission). As might be expected, a legal monopoly such as the one granted to the USPS for first class mail has enabled the USPS to raise prices by more than inflation over the period (or maybe this is simply evidence of the inefficiency of a government run monopoly; despite several structural cost advantages, USPS has failed to control its costs in line with inflation). UPS has no such legal monopoly, yet has been able to raise prices even faster. The source for such impressive pricing power can only come from a sustainable competitive advantage.
4. Competitors will continue to be rational in pricing decisions.
The Ground duopoly shared between UPS and FDX has exhibited increasingly rational pricing, as evidenced by converging prices and price increases, see “Difference” column below:
Average revenue per piece ($):
| $ | UPS Ground | FDX Ground | Difference |
| 1998 | 5.51 | 5.04 | 9.3% |
| 1999 | 5.65 | 5.36 | 5.4% |
| 2000 | 5.82 | 5.55 | 4.9% |
| 2001 | 6.03 | 5.79 | 4.1% |
| 2002 | 6.16 | 6.11 | 0.8% |
| 2003 | 6.36 | 6.25 | 1.8% |
| 2004 | 6.42 | 6.48 | 0.9% |
| 2005 | 6.76 | 6.68 | 1.2% |
| 2006 | 6.94 | 7.02 | 1.1% |
| 2007 | 7.14 | 7.21 | 1.0% |
| 2008 | 7.42 | 7.48 | 0.8% |
It is interesting to note that industry pricing became more rational with UPS’ conversion from private to public status in November 1999. The pricing difference between UPS and FDX in the Ground segment has shrunk from 9.3% in 1998 (when UPS was still private) to almost zero after a decade of public reporting. Increased public disclosure seems to have afforded the dominant player a compliant competitor in pricing strategy, without apparently requiring any anti-competitive behaviour.
5. The value being created by building international economies of scale is not obvious in current profits, and will ultimately be larger than the dominant US Ground business.
Looking back at large companies that have maintained growth within their core franchises for multiple decades (Coca Cola springs to mind) one lesson appears to be that it is very easy to underestimate how much further they could still go. Coca Cola believes that consumption levels of their products in many developing economies still present a long runway for growth. It strikes me that UPS is probably earlier in its own global story than Coca Cola, meaning that UPS should face a very long runway for growth, in sharp contrast to the apparent consensus that the company has hit its natural ceiling. Whereas Coca Cola is an affordable aspiration for many people who now have small amounts of surplus cash, and is adopted early on in a country’s economic development, UPS products probably only see peak demand at much higher levels of GDP/capita, which remain in the future for many countries. While US markets for both Coca Cola and UPS might be close to “maturity”, the saturation point for international markets should still be a very long way off. But that just talks to unit volume aspects. How about pricing?
Economies of scale are very costly to build, but very profitable in maturity. The UPS Ground business has taken one hundred years to build. The economies of scale in the international business are bigger in potential size, and might only just be starting to feed through to the bottom line. The international business was making a negative 26% contribution to total EBIT in 1994. Breakeven was reached in 1998, and it made a positive 28% contribution in 2008. These results represent both volume growth but also a deliberate pricing strategy in the UPS International business. During the late 1990’s, International (US origin) pricing was flat or low, while both UPS and FDX were building out their international capacity to meet rapidly growing demand for international small package traffic as globalisation took hold. UPS already had a much larger international domestic operation (domestic business outside of the US, e.g. ground package delivery in the UK) than FDX. But as cross-border traffic increased in the late 1990’s, unit volumes were neck and neck for both companies. Long accustomed to operating a dominant market share like Ground, and still smarting from the strategic mistake that had allowed FDX to penetrate and develop the US overnight network in the 1970’s-80’s, UPS adopted an aggressive pricing strategy while they were building scale in the International Export business. Now look at the disclosed pricing decisions history for International Export business, below. Larger market share (third column below) seems to have translated directly into pricing power:
| UPS International Export Ave. Daily package volume (000's) | FDX International Export Ave. Daily package volume (000's) | Market share indication: UPS Intl. Export unit volume relative to FDX (1.00=same quantity) | UPS Annual Pricing decision, International: US origin | |
| 1997 | 217 | 226 | 0.96 | 2.6% |
| 1998 | 256 | 259 | 0.99 | 0.0% |
| 1999 | 303 | 282 | 1.07 | 0.0% |
| 2000 | 368 | 319 | 1.15 | 2.9% |
| 2001 | 408 | 346 | 1.18 | 2.9% |
| 2002 | 443 | 340 | 1.30 | 3.9% |
| 2003 | 481 | 369 | 1.30 | 3.9% |
| 2004 | 541 | 396 | 1.37 | 3.5% |
| 2005 | 616 | 437 | 1.41 | 2.9% |
| 2006 | 689 | 466 | 1.48 | 5.5% |
| 2007 | 761 | 487 | 1.56 | 6.9% |
| 2008 | 813 | 517 | 1.57 | 6.9% |
| 2009 | 6.9% |
But this is just the US-origin International business; given the existing dominance of UPS in the US, the supposed pricing power shown above in international (US orgin) pricing decisions might merely reflect an extension of US pricing power. How about pricing power in other International Business? Notice in pricing chart #3 above that non-US origin International Business has an undisclosed annual rate setting strategy. That smells to me like a business that does not yet enjoy pricing power. This conclusion makes sense qualitatively, given how long it must take to build true cross-border economies of scale around the globe, and to produce networks as dense as those now evident in US ground. While this lack of pricing power is bad for current profits and could be negatively interpreted by those with a short-term horizon, in the long term it could be interpreted as a fantastic signal for the future. It means that international economies of scale are still being built, the company is still investing in growing its network, and suggests that the profits from this network once complete will be out of all proportion to historical earnings from this business, since, to repeat: economies of scale are costly to build but extremely profitable once complete. International economies of scale are a work in progress, but the results should be glorious.
Conclusion: International will likely become a much bigger business than US Ground; the market is larger, and once dominated, should promise significant pricing power courtesy of barriers to entry and lack of substitution of product. I think it does not take naïve optimism to consider that the best days for this company are ahead, not behind.
Risks to Thesis
“The future ain’t what it used to be” (Yogi Berra). The most obvious risk is a lack of growth even after the current macro slowdown. I can appreciate that stagnant activity might persist for several years in the US Air business. The trend of cost cutting could obviously last a very long time, entrenching the recent migration from Air to cheaper Ground deliveries. But the US Air business is not where UPS has traditionally enjoyed the strongest market position, as demonstrated by the 50% volume advantage enjoyed by FDX Next Day Air compared to UPS. The two UPS businesses that look most attractive to me are US Ground (dominant market share, potential benefits from LT shifts in retail) and International (as armand440 commented on the recent FDX thread “there is very little competition if one wants to get a package from Beijing to Chicago unless you are willing to wait 3 weeks”). US Ground should sustain profitability commensurate with a sustainable competitive advantage, and International reflects significant future promise as outlined above.
Irrational Competition from FDX or DHL. As two publicly traded companies with profit motives, this form of competition should be more economically rational and much easier to predict than non-economic competition (e.g. USPS).
Regulatory risks
1. US: possible USPS reform. USPS has excess capacity (resulting from a drop in first class mail volume), a large unfunded retirement and health plan, and is the third largest employer in the US (=votes). A US government seeking votes could try to solve this problem by, for example, extending USPS’ existing monopolies to include packages, or allowing USPS to use its monopoly profits to undercut UPS in competitive products (currently, competitive (non-monopoly) products must be priced by USPS at cost plus). An alternate scenario might be an unleashing of the dormant, sunk costs of the USPS network with greater efficiency by privatization in way that decreases UPS profitability. Intelligent experts with diverse biases and political views disagree over the likely impact of a privatisation of USPS. (The Postal Regulatory Commission, Government Accountability Office, Cato Institute and Federal Trade Commission have all published extensively on the subject in recent years). The benefits to USPS from its monopolies and other structural advantages (such as access to low cost debt, zero profitability requirement, practical immunity from parking tickets etc) might be more than offset by the burden of labour restrictions. If all USPS employees could be fired and replaced with new staff, this might be the biggest single threat to UPS domestically. But this also might prove an intractable solution, which never happens due to political issues. Another risk could be that private sector profits simply get appropriated by an interventionist government either to help fund the US Postal Service (already approaching $15 billion Statutory Debt Limit due to ongoing significant operational losses) or to provide unprofitable social aspects of package delivery (e.g. Ground Residential surcharges become illegal).
2. International regulatory risks. In many countries, postal services tend to have a lot of government influence, although privatisations have increased over the past decade. But regulatory threats globally will remain key risks, e.g. Private operators in China are potentially required to contribute 4% of gross revenues to fund remote rural postal deliveries.
Pension and medical. Disclosed net benefit obligations of approx. $20 billion are large relative to enterprise valuation, meaning that embedded risks such as longevity and investment risk are significant relative to company valuation. Despite attempts to manage these exposures, notably with a $6.1 billion payment in 2007 to withdraw from the Central States Pension Fund, this will continue to be an area of investor concern. Such is the nature of long-established businesses where compensation costs run 50-60% of sales. I currently assign an additional 5% to EV (liability) for this; I am not a pension expert.
Labour Strikes. A re-run or worse than the only nationwide strike in company history: the 1997 Teamster strike, which ran for 16 days costing $750 million (4% of implied 1997 enterprise value) and much goodwill.
Technological change is both a risk and an opportunity. Several technological developments have recently reduced the demand for time critical small package delivery. More might happen in future. For example, if new aircraft or vehicle technology favours new fleets, costly upgrades might be required.
War. Unconventional (biological etc): could devastate the small package delivery industry. Conventional: potential confiscation of company assets (property, trucks, planes) during times of war by non-US governments. The US already has an agreement to use company planes during war; full compensation might not be forthcoming. Given a long enough holding period, some form of this scenario will probably happen, unfortunately.
Forced pollution control: UPS operates the largest US private fleet in any industry, and a large aircraft fleet worldwide.
Generic risks: management incompetence, macro risks etc
Miscellaneous things I like about UPS
Some alignment of incentives. Way before employee stock ownership ever became fashionable, founder Jim Casey (1888-1983) began rewarding employees with stock in the private company in 1927. Ever since, the company’s moat has been built inch by inch by a workforce who has owned a stake in the company’s long-term success. Casey clearly understood the power of aligned incentives, justifying his 1927 decision: “There is no bigger incentive than for someone to work for himself.” Much later in the company’s growth, he observed: “Employee-ownership is credited by the people inside and outside the company with having done more than any other thing toward making our company and our people so notably successful financially and otherwise.” Current and former employees continue to own 30% of the company’s stock today.
Executive compensation has a tradition of restraint. CEO total comp has historically maxed out at $5-6 million, CFO at $2.0-2.5 million. Investors therefore benefit from executive management of large cap quality at small cap prices.
The bad news is already in the price on taxes and labour. Higher effective corporate tax rates and greater labour protection are two typical results of increased Government spending and indebtedness. For several large cap peers, this suggests that their “new normal” will in fact be lower profitability. UPS effective tax rate is already 38%, (cumulative cash tax rate past decade of 34.4%), meaning that greater tax scrutiny should not reduce their post-tax earnings as much as some other companies with much lower historical tax rates. UPS has 90 years of experience of operating a union dominated workforce (260,000 out of 426,000 current employees are Teamsters members) and on the whole has managed to obtain contracts with many flexible features. Competitors like FDX might struggle more than UPS in a new environment of labour rigidities.
Potential Catalyst
The “turn” in earnings should be accompanied by some vigorous share repurchases, approx 13% of current market cap.
In January 2008, Chairman and CEO Scott Davis was promoted from his CFO role which he had held for 7 years. As a finance guy who must have long contemplated what he would do when he finally hit the top of the tree, the first strategic shift that he announced, on January 9, 2008, was a significant stock repurchase, to be financed by greater balance sheet leverage.
“Under the new policy, UPS intends to significantly increase the debt component of its balance sheet. Going forward, the company intends to manage its balance sheet to a target debt ratio within a range of 50-to-60% funds-from-operations-to-total-debt. Previously, there was no stated metric.”
Careful readers will note that this happened right at the start of what turned out to be quite a nasty year for stocks. Originally planning to buy back $10 billion of stock from January 2008 to December 2009, the new CEO proceeded according to plan, buying $1.25 billion each quarter in Q1 and Q2 08 (average price $70), then as the full horror of what he was walking into gradually became apparent, he slowed down a bit in Q3 2008, buying only $0.8 billion (ave. $63), before finally throwing in the towel in Q4 2009. Since then, repurchases have been reduced to a whimper, and policy has been to “repurchase shares at a rate that will at least offset dilution from stock-based compensation. At this point sustaining the dividend is a higher priority than expanded share repurchases.” (Q1 2009 earnings call).
Ouch. So much for the bold new approach from the finance guy.
Now what to do? Well as any value investor knows, if the thesis is intact, one response to lower prices is to buy more and improve your average. Management repurchased $3.5 billion at $66.80, yet still has $6.5 billion of dry powder repurchase authorization as of March 2009, and originally intended to complete the purchases by December 2009. This would equate to about 13% of the current market cap. So what could trigger a completion of the plan?
Note the reply to Ed Wolfe’s question in the Q3 2008 earnings call:
Q: “now that the stock's sitting here with a 4 handle in front of it, it's quite accretive
to go in there, and I understand the credit markets aren't great. But you're certainly not having a lot of trouble with access, it seems, to capital. How do we think about those two conflicting things as we go forward in the near term - the stock down here, and the markets - in terms of your guidance of 5 billion a year of share repurchase?”
A: Kurt Kuehn: “Yeah, you know, Ed, this really has been an unprecedented time for turbulence, in the debt markets especially. And we've been fortunate in that we've really had as much access to commercial paper as we need, and at very, very beneficial rates. So the liquidity is there. On the other hand, the long-term debt markets still show some very sizable spreads, and ultimately our share repurchases will manifest themselves in longer-term debt. On the other hand, as you say, UPS stock is on sale today at a great price, and certainly we intend to be buyers. The exact pace of it will depend on conditions, both in the debt markets and the equity markets, but we do intend to be in there buying stock.”
Scott Davis: “We love the stock, obviously, at this price. We'd like to actually get it up to a higher price, but I think that Kurt said it right. The long-term debt markets need to stabilize. There has not been a lot of corporate debt issuance over the last two, three months. And we need to see that stabilize.”
The first hurdle to returning to the repurchase program – evidence of credit market normalization - seems to have already been cleared. UPS 10 year CDS has dropped from its December 2008 high of 200bps to 47bps recently. The company successfully issued $2 billion of term debt at 3.88% (5yr) and 5.13% (10yr) in Q1 09, although some of this was simply re-financing. They have plenty of borrowing capacity, including $6.8 billion room under a U.S. commercial paper program (on which the Q1 09 average rate was 0.29%). This financially conservative company would appear to have plenty of room to borrow.
Although mere deduction from public facts, I conclude that once management feels that it has regained some earning visibility and if the stock price has not pre-empted them, I would expect them to complete the rest of the balance sheet restructuring originally announced in January 2008 and make repurchases valued at about 13% of the current market cap.
Conclusion
You may say that I'm a dreamer ($6-9 billion normalized ebit plus growth, are you kidding?)
But I'm not the only one ("efficient" market consensus was there only 15 short months ago)
I hope someday you'll join us (or simply correct me)
And the world will be as one (if not unified by love, at least united by one dominant small package network).
Notes and definitions
*coefficient of variation: standard deviation / mean.
Pre-tax ROC: EBIT/(net working capital less short-term interest bearing debt plus net fixed assets).
UPS 2007 $6.1 pension contribution excluded from operating earnings.
Header figures (eps etc) are consenus.
Apologies for woefully incomplete reference citations, will cover sources in Q&A if interested.
The “turn” in earnings should be accompanied by some vigorous share repurchases, valued at approx 13% of current market cap.
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