Analysis: UPS

UPS (UPS) hosted its investor and analyst conference Wednesday (additional details can be found here), and ahead of the event, the team provided a press release laying out strategic priorities, three-year financial targets and new environmental, social, and governance goals for the company.

"We are creating a new UPS, rooted in the values of the company. Our strategic priorities are evolving to reflect the changing needs of our customers and our business, and what matters most to our stakeholders," said CEO Carol Tomé on the press release.

The strategic priorities can be broken down into three areas: Customer firstPeople led and Innovation driven.

"Customer first," according to the release, means providing the best digital experience possible and the removal of as much friction as possible when doing business with UPS. To quantify the improvements here, UPS is targeting a 2023 NPS score of 50 or higher and plans to achieve this target by focusing on the "wildly important" of small/medium business (SMB), health care and international end markets, as well as overall brand relevance.

Notably, management is targeting $10 billion in health care sales across three segments (indicating a 12.3% compound annual growth rate from 2020 to 2023).

Internationally, the team sees UPS' addressable market growing from $86 billion in 2020 to $103 billion in 2023 -- representing a 6% CAGR.

"People led" means improving the employee experience to the point that more employees would recommend UPS as a place to work. To quantify progress on this front the team is establishing a 2023 "likelihood to recommend" target of 80% or greater.

"Innovation driven" means a focus on technology and productivity to deliver "consistently higher returns on invested capital, as well as returns to shareowners through dividends and share repurchases."

On the innovation front, the team is working to simplify the fulfillment process and provide enhanced visibility and control to shippers via their CoyoteGo platform -- which will also help make parking easier for commercial drivers. The Orion (On Road Integrated Optimization and Navigation) platform is also being leveraged to optimize routes and save miles and fuel as a result.

Speaking of fuel savings, we expect to see further reductions as the company transitions to electric vehicles -- previously committing to purchase 10,000 Arrival (which UPS has an investment in) electric vehicles, with an option to buy another 10,000.

Additionally, as a reminder, the team is also looking at the potential for eVTOL (electric Calvert Takeoff and Landing) aircraft to further enhance its logistics network.

Bringing the entire digital supply chain together is Symphony, which allows customers to access their "UPS-managed warehouse and transportation data from one portal, one single source of truth."

As for 2023 financial targets, management is targeting revenue in the range of ~$98 billion to ~$102 billion. Adjusted operating margin is expected to come in at approximately 12.7% to 13.7%. Capital spending from 2021 to 2023 is expected to be roughly $13.5 billion to $14.5 billion and adjusted return on invested capital of about 26% to 29%.

During her keynote speech, Tome spoke to some of the assumptions that went into this guidance. At a high level, the team believes that 2020 was an inflection point for small package growth due to the online shopping dynamic resulting from the COVID-19 pandemic and sees an accelerated growth rate in this market segment for at least the next few years. Globally, the team sees the small package market accelerating to a 10% CAGR through 2023 whereas management believes the U.S. Domestic small package market will grow at an even faster 12% CAGR through 2023.

Chief Marketing Officer Kevin Warren also spoke to the importance of winning SMB customers, calling out that this cohort is a huge opportunity for the company as the team sees U.S. domestic SMB market growth accelerating from a 3% CAGR in the 2016 to 2019 timeframe, to an 8% CAGR from 2019 through 2023.

To win this business, the team will invest in core capabilities by expanding weekend operations and working to increase speed and ease of use for the SMB cohort. The team will also invest in "adjacencies" by implementing a new global pricing platform and improving the digital supply chain. The new global pricing platform could shave up to three days off of the shipping process of SMBs while the digital supply chain investments will result in over 150 enhancements to the tracking experience. Notably, these investments have "already reduced claims time from 20 days to 5 days."

Speaking on "Operational Excellence," the president of U.S. operations, Nando Cesarone, spoke about the "productivity flywheel," highlighting that the team managed to reduced key performance indicators from 462 to less than 10, eliminated unnecessary costs in the first quarter of 2021, increase weekend deliveries by over 46%, and improved driver efficiency by reducing package-selection time by up to 25%, eliminate ~11,000 container movements per week. The company also leveraged automation to reduce handles by 7.6% on volume flowing through 17 of the company's largest hubs in February and increased safety initiatives -- which resulted in a 6% reduction of most severe accident frequency in the first quarter of 2021.

CFO Brian Newman also provided details on these financial targets. The bulk of the revenue increase will be achieved by U.S. domestic revenue growth and international market share gains, while U.S. domestic margin expansion represents the largest contributor to overall margin expansion. Of course, achieving these two goals is what will allow management to reach their adjusted operating margin target while a combination of operating profit expansion and a focus on disciplined capital allocation is how the team will realize their return on invested capital objective.

Regarding capital allocation, UPS has four priorities: reinvest in the business, maintain a stable and growing dividend, maintain a strong balance sheet and credit rating and share repurchases. 

Source: UPS estimate provided during 2021 investor & analyst day

Looking at capital expenditure, as a percentage of revenue this line item is expected to decline from ~6% in 2020 to around 4.5% to 5.5% cumulatively in the 2021 to 2023 time period. Of the $13.5 billion to $14.5 billion spent during that period, 65% will be targeted toward growth initiatives with the remaining 35% focused on maintenance.

We should also note that UPS plans to achieve total free cash flow of $24 billion to $27 billion in the 2021 to 2023 time frame, a key goal that will provide for the various investments noted above and allow the team to achieve another goal of repaying $6.9 billion of maturing debt.

Finally, on the ESG front, in the long-term, the team is pledging "to be carbon neutral across scope 1, 2 and 3 emissions in its global operations by 2050." In the near-term, by 2025, UPS plans to have 25% renewable electricity for facilities and 40% alternative fuel of ground vehicles. In the mid-term, by 2035, UPS plans to reduce CO2 per package delivered for its global small package operations by 50% (compared to 2020 levels). Additionally, the team is planning to have 100% of their facilities powered by renewable energy and for 30% of fuel used by the global UPS air fleet to be sustainable aviation fuel.

All in, the event was a solid update for the company, however, as noted in our trade alert earlier today (here) was not quite enough to meet elevated expectations and as a result shares have been met with a "sell the news" reaction.

That said, we believe the team is making all the right moves for longer-term growth and is on the path to realizing management's "better not bigger" objective. This echoes commentary from analysts at Deutsche Bank who commented in a reaction note, following the event, saying "we continue to view UPS shares as very compelling in the context of structural earnings power. Shares, however, are underperforming a bit today on the back of what we consider to be very conservative guidance." The analysts ultimately concluded, "Net/net we have been here before with UPS shares. UPS mgmt. appears to be doing the prudent thing - putting out targets that are achievable under many different and unforeseen circumstances ... but the true potential is higher."

In their view, we could be looking at "true EPS power just above $14 per share in 2023 (and on track to our $15+ in 2024E)." 

As a result, we opted to upgrade shares to a "One," and reiterate that Wednesday's selloff represents an opportunity for longer-term investors, thanks to the improving underlying business fundamentals we have seen thus far and expect to see in the years ahead.

Action AlertsPLUS, which Cramer co-manages as a charitable trust, is long UPS.