Recommendation: BUY United Parcel Service (UPS);
Sell NG, JOYG, BHP
Industry Overview
Industry demand drivers:
• E-commerce
• Emerging economies
• Trade
2
Company Profile
UPS is the world's largest express carrier, specializing in time-definite package delivery and a
growing presence in specialized transportation and logistics services. UPS delivers packages
for more than 1.1 million shipping customers to 7.4 million consignees each day in over 220
countries and territories, using a network of 99,800 delivery vehicles, 527 planes, and 400,600
employees as of December 31, 2010. In 2010, UPS delivered 15.6 million pieces per day and
recorded $49.5 billion in revenue.
3
Investment Information
4
UPS v. FDX
In Search of Superior riskadjusted returns
UPS Outguns FDX:
1. Lower volatility (beta)
2. Higher yield
3. Stronger profitability
5
UPS v. FDX
UPS
FDX
Total Returns
24%
42%
Standard Deviation
7.53
17.55
Risk-adjusted returns
3.20
2.37
Notes:
• Returns since January 1, 2003
• Adjusted for dividends
• Risk adjusted returns = (TotalReturns%*100)/standard deviation
• Past performance does not guarantee future results
6
Chart: Buy the Dip
7
Chart: Oversold and Bottoming
8
Key Investment Points
#1: Pricing power – domestic duopoly, international oligopoly
#2: E-commerce tailwind for long-term growth
#3: Return of capital to shareholders
9
Source: Company reports, BofA Merrill Lynch Global Research estimates.
#1: Pricing Power
As shown in Chart 3, margins are stalled halfway rebounding from its prior peak
owing to the volume shortfall, despite the recent pickup in pure pricing (see Chart
1).
Chart 3: Corporate EBIT margins still well off peak as volumes remain shy
15.0%
14.0%
Room to go on
corporate margins
to return to peak
14.1%
14.0%
13.5%
12.7%
13.0%
11.6%
11.8%
12.0%
11.0%
10.0%
8.8%
1. DHL competition
2. Oil price spike
3. Recession / avg weight down
9.0%
8.0%
2006
2007
2008
2009
2010
2011e
2012e
Source: Company reports, BofA Merrill Lynch Global Research estimates.
10
UPS noted that domestic operating margins in 3Q would begin to slow as it laps
cost cutting and restructuring benefits from 2010. As average daily ground
volumes remain 400,000 below peak levels (3.4% shy) at 11.2 million daily
Ground packages per day, it has latent capacity which compresses its margin
potential.
#1: Pricing Power
Chart 2: Ground volumes still below peak levels – leaves room for margin upside as
volumes fill fixed cost network
Still 400,000 shy of
2007 peak (3.4%)
11,800
11,622
11,600
11,546
11,522
11,463
11,400
11,199
11,150
11,200
10,914
11,000
10,800
10,600
10,400
2006
2007
2008
Source: Company reports, BofA Merrill Lynch Global Research estimates.
2009
2010
2011e
2012e
11
#1: Pricing Power
4 competitors: UPS, FDX, DHL, USPS
•
DHL: Low cost provider exited domestic express land/air market in 2009
•
DHL continues to offer international and heavy weight shipping
•
USPS considering more limited services
•
UPS and FDX now have greater pricing power
12
#1: Pricing Power
13
#2: E-commerce: US
14
#2: E-commerce: US
15
#2: E-commerce: China
16
#3: Return of Capital
Diluted Shares Outstanding
1,200,000
1,150,000
1,100,000
1,050,000
1,000,000
950,000
900,000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
Reduced share count by >2% per year since 2005
TTM
2011E
17
#3: Return of Capital
Dividend
$2.50
$2.00
$1.50
$1.00
$0.50
$2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
Dividend CAGR 10% for the last decade
18
SWOT Analysis
Strengths
 Strong competitive position – duopoly
 International growth, esp. Asia
 Scale / profitability
 Strong cash flow, financial flexibility
Opportunities
 USPS cutbacks
 Price increases
 Increase buy backs, dividends
 New distribution partnerships
Weaknesses
 Capital intense
 Unionized labor force
(agreement runs through July 2013)
Threats
 Labor strike
 Oil prices
 Recession
 Price war with FedEx, USPS
 Mkt decline / pension funding
19
Valuation
Dividend Discount Model
Beta
Rf
MRP
Required Return
5-yr Dividend Growth Rate
Dividend
Fair Value
DCF Model
0.89
2.33%
8%
9.5%
7.30%
2.08
$96.74
P/E Price Target
2012E EPS
$5.16
1-yr average forward P/E
17.0x
Price Target
$87.72
Terminal growth rate
2.50%
Terminal FCF
$3,986
/(r-g)
Discount factor
$83,562
$1.45
PV TV
$57,480
+ PV of FCF
$12,867
= Enterprise Value
$70,347
less debt
$12,170
add cash
$5,640
= Equity Value
/ Shares
Fair Value
$63,817
981
$65.07
Note: UPS' FCF potential is likely understated as
margins have fallen.
20
UPS - Fwd P/E
Average
8/26/11
8/12/11
7/29/11
7/15/11
7/1/11
6/17/11
6/3/11
5/20/11
5/6/11
4/22/11
4/8/11
3/25/11
3/11/11
2/25/11
2/11/11
1/28/11
1/14/11
12/31/10
12/17/10
12/3/10
11/19/10
11/5/10
10/22/10
10/8/10
9/24/10
9/10/10
8/27/10
Valuation
UPS Forward P/E
20.00
19.00
18.00
17.00
16.00
15.00
14.00
13.00
12.00
21
Valuation: Which Method?
• Given the company’s record of consistent dividend increases, DDM appears
most appropriate
• However, each valuation method in sensitive to the assumptions used to
derive the inputs
• An average of the methods yields a more conservative 12-month price target.
Valuation Summary
Dividend Discount Model
P/E Price Target
DCF Model
Average
Current Price
Upside
$96.74
$87.72
$65.07
$83.18
$64.70
29%
22
Portfolio Recommendation

BUY 150 shares of UPS at a limit price of $64 ($9,600,
2.1% of portfolio)

Sell 100 JOYG @ Market (~$83.45, $8,345)

Sell 125 BHP @ Market (~$85.17, $10,646)

Sell 400 NG @ Market (~$10.30, $4,121)
23
Portfolio Recommendation
Industrials

Target Sector Allocation: 7.3%,

Current Sector Allocation: 3.3%

Allocation after sale: 1.6%

Allocation after purchase: 3.7%
24
Portfolio Recommendation
Materials

Target Sector Allocation: 2.4%,

Current Sector Allocation: 5.4%

Allocation after sales: 2.2%
25
Sell Rationale
Materials

BHP: Levered to China, fairly valued in an uncertain
market = sell

JOYG: Similar to BHP. Repurchase if the stock falls to
$55 or below. Expect the stock to fall no further than the
upper $40s. I would highly recommend a repurchase.

NG: Will need to raise funds by issuing stock. We can
repurchase after the secondary if we so desire.
26