This is a tale of two industrial giants. United Parcel Service (UPS 0.53%) is facing challenging end markets but is executing admirably and will emerge from the slowdown in better shape. In contrast, Boeing (BA 1.51%) faces tremendous end-market demand, and it needs to execute better and take advantage of an improving (but still tricky) supply chain environment. Nevertheless, based on what UPS and Boeing are telling investors, both companies are attractive for 2023. Here's why these two stocks are compelling buys in February.
1. UPS delivers
Global growth is slowing, and that's not usually good news for package-delivery companies. Indeed, CEO Carol Tome told investors on the recent fourth-quarter earnings call that "we expected volume levels to decline from last year, and they did, but more than we planned due to macro conditions." Moreover, management is planning for volume declines in its U.S. domestic package and international package segments in 2023.
That said, however, UPS is still highly attractive based on estimated 2023 valuations, and the underlying development of its business is excellent.
Regarding valuation, taking the midpoints of management's revenue ($97 billion to $99.4 billion) and adjusted operating profit margin (12.8% to 13.6%) guidance gives an estimate of around $13 billion in adjusted operating profit in 2023 compared to $13.9 billion in 2022. It's an outlook close to Wall Street assumptions and is based on the latter's EPS consensus of $11.54 in 2023.
UPS trades at 16 times estimated earnings. Moreover, the stock trades at 20.5 times management's estimate for free cash flow of $8 billion in 2023. If you consider that 2023 will be a trough, these are excellent valuations for a business with plenty of earnings potential.
As an example of the company's operational improvements, I would highlight that even though volumes declined in the fourth quarter, much of the dip is due to the company's successful plan to focus on profitable deliveries. For example, in the U.S., domestic volume declined 3.8% in the fourth quarter, but "about half of the decrease" came from UPS' largest customer (Amazon.com) "per the mutually beneficial contractual agreement we reached some time ago," according to CFO Brian Newman on the earnings call.
As you can see in the chart below, UPS continued increasing U.S. domestic package revenue even as volumes fell year over year for much of the last two years. However, the segment's adjusted operating profit was up 7.5% year over year in the fourth quarter and up 12.8% for the full year.
Data source: UPS presentations.
Moreover, the company's transformational strategy (focusing on growing revenue in targeted markets like small and medium-sized businesses, or SMBs, and healthcare) is working. SMBs made up 28% of U.S. volume in 2022 (up from 26.8% in 2021), and healthcare revenue is expected to grow from $9.2 billion in 2022 to $10 billion in 2023.
All told, UPS faced challenges in 2022, but the underlying improvements in the quality of its earnings mean it's well placed to grow again in 2024 and beyond.
2. Boeing is ready for takeoff
After a few tough years of substantive cash outflows and ballooning debt, Boeing appears to be on the right track. In a nutshell, the case for buying the stock is based on the idea that Boeing can ramp up the production of its commercial airplanes while being free of any more significant cost overruns on defense projects. So far, so good on the latter in 2023, with management not reporting any substantial issues or charges.
As for the all-important issue of increasing airplane production, Boeing remains hampered by ongoing supply chain challenges as it seeks to deliver on its multiyear backlog.
Still, there's evidence of improvement coming through from its suppliers.
- For example, Larry Culp, CEO of Boeing's key engine supplier, General Electric, expects "LEAP engine deliveries to grow about 50%" in 2023. The LEAP engine is the sole option on the Boeing 737 MAX and is also one of two options on the Airbus A320 neo family.
- Meanwhile, the CEO of another key component supplier, Raytheon Technologies, Greg Hayes, doesn't see "anything in our supply chain today that would prevent us from delivering either at Boeing or Airbus to the rates that they need."
- In addition, management of another Boeing and Airbus supplier, Triumph Group, recently said, "Intensive management of our supply chain enabled us to improve supplier on time, and full deliveries from 77% to 87%"
Whisper it quietly, not least because Boeing CEO Dave Calhoun is being cautious on the matter, but the aerospace and defense supply chain is slowly improving, and that's good news for Boeing.
