What's Driving Our UPS $85 Price Estimate

| About: United Parcel (UPS)
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United Parcel Service (NYSE:UPS) is the world's largest package delivery company catering to customers in over 220 countries. It is also one of the leading players in the global supply chain management solutions. The company generated revenues of $54.1 billion and operating income of $1.34 billion in 2012, which was dragged down by mark-to-market charges of around $4.8 billion associated with the pension plan. Here, we look at some of the key trends driving the company's valuation.

Retail e-Commerce Fueling Volume Growth in U.S. Domestic Package

The U.S. domestic package division makes up almost 60% of our estimated value for UPS' stock. It provides time-definite, money-back guaranteed, small package deliveries through its extensive network of both ground and air transportation services. Customers can choose from various offerings depending on delivery speed. Similar to FedEx (NYSE:FDX) SmartPost, UPS offers SurePost that leverages U.S. Postal Service's extensive ground delivery system to provide economic, non-urgent small package delivery services to residential addresses throughout the U.S. On the other hand, My Choice offers a highly customized delivery solution for similar packages.

U.S. domestic package volume grew by 2.8% year over year in 2012. The volume growth was fueled primarily by continued strong growth in retail e-commerce as an increasing number of consumers are migrating to the new way of shopping, however growth in business-to-business volume was muted reflecting the lack of growth in small and medium-size enterprises. We expect business-to-consumer volume growth to extend in the coming years backed by increasing e-commerce penetration, while business-to-business volume growth would largely depend on the improvement in the business investment environment led by reduced policy risks and strategic fiscal consolidation.

We forecast revenue per domestic package to increase over the forecast period primarily due to periodic revision of base rates and fuel, residential, delivery area and other surcharges with a positive impact from a favorable product mix in the long run. These surcharges keep the company's operating margins relatively immune to volatility in fuel prices and other operational uncertainties. Hence, we expect EBITDA margins to remain relatively stable over the forecast period aided by operational efficiencies.

Emerging Markets and Global Trade Expansion Key to International Package

The international package division makes up more than 28% of our estimate for UPS' stock. The division has operations in Europe, Asia, Canada and Latin America. Europe makes up more than half of the company's international segment revenues. The segment revenues grew by 10% year over year in 2011. However, a slowdown in emerging economies and unfavorable currency impacts resulted in 1% decline in 2012. We are positive on the long-term growth prospects of the international operations based on two broad-based industry-wide trends: emerging markets growth and expansion of global trade.

The fast-growing economies of Asia-Pacific and Latin America offer long-term, high-growth potential in domestic delivery markets. The real GDP growth rate of China was 7.4%, while India is expected to grow by around 6% in FY 2012. These are much higher compared to the expected GDP growth rate of 2.1% in the U.S. during the same period.

Understanding this opportunity, UPS has been steadily expanding in emerging markets. Typically, it enters a new market through imports and exports, then expands domestically with a partner and finally acquires the domestic operations wholly if it sees sustained growth potential. It has used this strategy successfully in China where it is one of the few wholly owned foreign express carriers today. Further, intra-Asia trade driven by these fast-growing Asia-Pacific economies will continue to be a key growth driver that will add to growth at UPS' international delivery segment.

Moreover, as we move toward efficient markets for products and services, global trade is expected to grow in the coming years. Advancements in technology have reduced travel time and businesses have leveraged the advantage to grow efficiently. As a result, U.S. and international economies are becoming increasingly dependent on foreign trade. UPS is expected to leverage its extensive reach in global markets and take advantage of this trend over the forecast period.

We currently have $85 price estimate for the company which is in line with the market price.

Disclosure: No positions.