Where Will UPS Be in 3 Years?

Thanks to management outlining its 2023 targets, investors have a good idea of where UPS (UPS +0.98%) wants to be in a few years. However, what will the stock's earnings trajectory look like at that time? It's a critical question because investors tend to price in future earnings rather than solely looking at past earnings. With this in mind, let's take a look at where UPS could be in a few years.

UPS' 2023 targets

It's a good idea to recap the critical parts of the company's targets given in the investor day presentations in June. Management expects revenue to grow by 5%-6.4% yearly, with overall margin expansion leading to a 12.5%-17.2% per year increase in operating profit to $12.4 billion to $14 billion.

Image source: Getty Images.

UPS makes money from three segments. The U.S. domestic package segment contributed 48.6% of operating profit in the first half, with international package contributing 37.7%, and the supply chain solutions segment was a distant third with 13.7%.

The majority of the targeted 2023 profit growth is forecast to come from a combination of growing revenue in the international package segment and the U.S. domestic package growing revenue and margin. As a result, management expects the U.S. domestic package segment to drive overall profit margin expansion from 2020 to 2023.

Data source: UPS presentations.

UPS' valuation in 2023

To put the figures above into the context of what UPS' valuation could look like, here's a look at the Wall Street consensus for operating profit or earnings before interest and taxation (EBIT) in the coming years. The final row shows the market-cap-to-operating-profit multiple based on the current market cap of $169.3 billion remaining constant. Thus, the lower valuation multiples reflect the substantial increase in operating profit.

If you prefer to look at price-to-free-cash-flow (FCF) multiples, management expects the company to generate $24 billion to $27 billion in FCF over the next few years. Wall Street analysts have UPS generating $9 billion of FCF in 2023, giving it a price-to-FCF multiple of 18.7 in 2023.

Data sources: Marketscreener.com and author's analysis.

The forward multiples for UPS do not look demonstrably cheap. However, they do look a good value provided you are convinced that the company can continue to grow its revenue and margin from 2023 onward.

What about growth after 2023?

The debate around the subject, and the investment case for UPS in general, centers on the discussion on the U.S. domestic package margin. Will surging e-commerce delivery volumes translate into margin expansion and revenue growth in the U.S. segment?

The bearish outlook is that e-commerce volume growth, particularly business-to-consumer (B2C), brings margin challenges because they can be costly to deliver, inefficiently packaged, and hard to deliver to residential addresses. Moreover, both UPS and FedEx have a patchy record of generating profit margin growth in recent years.

Data by YCharts.

The counterargument is that there isn't a problem with e-commerce volume growth, so there should be ample opportunity for the package delivery giants to be selective about deliveries. In other words, focus on higher-margin deliveries. Indeed, UPS is doing precisely that by focusing on growing its small and medium-sized business (SMB) revenue, so it can grow in line with its customers growing their e-commerce operations. At the same time, UPS is increasing its healthcare-based revenue and focusing on profitable delivery growth. It's a line of thinking at the heart of CEO Carol Tome's "better, not bigger" approach.

As such, the bullish view agrees with management's guidance for U.S. domestic package margin to expand to 10.5%-12% in 2023 from 7.7% in 2020.

Image source: Getty Images.

A snapshot of 2023

There's reason to be optimistic. Let's put it this way: If UPS does hit its 2023 targets, it will have demonstrated that it can grow margin and revenue at the same time. In addition, it's likely to have been successful in expanding in the SMB market, among others.

All told, it isn't simply a case of UPS hitting its 2023 targets and stopping. Instead, a snapshot of the business in a few years should show a company with a reasonable valuation that's on track with its growth strategy. If that's the case, then UPS will be able to expand margin post-2023 as well. Moreover, since no one doubts the growth potential in e-commerce, it gives UPS a substantial earnings growth opportunity for years to come.