By now, most investors will know that UPS (UPS -1.06%) reported a bumper set of fourth-quarter earnings, and the stock soared higher in response. In a nutshell, the company is on track to meet its 2023 targets a year early. However, the party isn't over by a long shot. The trend in its numbers and operational trends suggest there could be plenty more upside to the stock to come. Here's why.
UPS is ahead of its targets
It's a good idea to start by recapping the 2023 targets laid out on the investor day in June 2020. The key points are in the table below.
Image source: Getty Images.
First, not only is UPS set to hit its 2023 targets a year early, it's driving toward the high end of them and above. The 2022 revenue and overall adjusted operating margin guidance are at the high end of the 2023 targets. Meanwhile, the all-important U.S. domestic operating margin guidance for 2022 is above the midrange of the 2023 target.
Finally, the 2021-2023 free cash flow (FCF) target of $24 billion to $27 billion looks well within reach, given the $10.9 billion generated in 2021 and the $9 billion guidance for 2022. If UPS hits FCF guidance in 2022, it will need just $7.1 billion in 2023 to hit the high end of its 2021-2023 target. That looks achievable.
|
UPS Metric |
2021 |
2022 Guidance |
2023 Target |
|---|---|---|---|
|
Revenue |
$97.3 billion |
$102 billion |
$98 billion to $102 billion |
|
Adjusted operating profit |
$13.1 billion |
Implied guidance of $14 billion |
$12.4 billion to $14 billion |
|
Adjusted operating profit margin |
13.5% |
13.7% |
12.7%-13.7% |
|
U.S. domestic adjusted operating margin |
11.1% |
11.6% |
10.5%-12% |
|
Free cash flow 2021-2023 |
$10.9 billion in 2021 |
$9 billion in 2022 |
$24 billion to $27 billion |
Data source: UPS presentations.
The meaning behind the numbers
There are two key reasons investors should feel good about the earnings and guidance. They relate to the debating points around UPS and FedEx in recent years. The first concern is that burgeoning e-commerce growth leads to significant margin pressure due to costly business-to-consumer deliveries that are often bulky, inefficiently packaged, and involve multiple hard-to-reach delivery points.
The second concern is that both companies will find themselves locked in a never-ending cycle of capital spending to build out networks to service surging e-commerce volume. Again, that's something that could pressure FCF generation.
Fortunately, UPS is winning both debates. As you can see above, U.S. domestic package margins are expanding nicely, and CEO Carol Tomé's "better, not bigger" framework is working. In a nutshell, UPS focuses on building revenue quality rather than chasing e-commerce volumes.
Turning to FCF, not only is UPS ahead of the 2021-2023 guidance, but CFO Brian Newman outlined on the earnings call that capital expenditures in 2022 would be $5.5 billion. It's a figure equivalent to 5.4% of revenue. That's fine on a historical basis. Given that 60% of the expenditure is for growth projects and UPS forecasts a return on invested capital of above 30% in 2022, it makes perfect sense.
All told, UPS investors shouldn't worry too much about margin expansion and FCF generation.
Data by YCharts
Operational improvements
In addition to the headline numbers, UPS is demonstrating substantial progress on its transformational initiatives. Two key elements of the plan involve growing its small and medium-sized business revenue using its digital access program (DAP) and its healthcare revenue.
Both initiatives received a boost due to the pandemic. Small businesses rushed to build out online sales, and medical bodies distributed vaccines and healthcare equipment. For example, where Tomé was previously looking for $1 billion in revenue through DAP in 2020, she now expects $2 billion in 2022. In fact, DAP is so successful that UPS is now taking the program outside the U.S.
Image source: Getty Images.
Meanwhile, healthcare-related revenue now stands at $8 billion, and the company is on track with its target of $10 billion in revenue in 2023.
A stock to buy
UPS still looks like a good value based on its FCF generation in 2022. Around $9 billion in FCF would put UPS at an FCF price multiple of 22 times the estimated FCF in 2022. That may seem a little high, but recall that UPS is in expansion mode, and its $5.5 billion in capital spending in 2022 will far exceed its depreciation of around $3 billion. Meanwhile, UPS looks set for revenue and margin expansion in 2023 as its underlying trends remain strong. There's more to come from the company that investors will likely enjoy.
