UPS Financial Valuation James Ward, Mark Childers, Larry Abney, Josh Wayman
UPS 1
Executive Summary
Investment Recommendation: Fairly Valued, Hold 4/1/2007 UPS - NYSE $70.10 EPS Forecast
52 Week Range $65.50-83.99FYE 12/31 2006(A) 2007(E) 2008(E) 2009(E)
Revenue (2006) in mil $47,547 EPS 3.46 $3.79 $4.05 $4.37 Market Capitalization in mil $75,708 Shares Outstanding 1,080,000,000 Ratio Comparison UPS FDX DHL
Dividend Yield Trailing P/E 21.46 16.1 8.69
3 month Avg. Daily Trading Volume 3,901,120
Forward P/E 19.91 13.08 8.69
Percent Institutional Ownership 64% M/B 2.36 2.36 1.12Book Value Per Share $14.47 ROE 24.89% Valuation Estimates
ROA 11.93%Actual Price @ 4/1/07 $70.10
Est. 5 year EPS Growth Rate Ratio Based Valuation
Ke 13.09%P/E Trailing $65.71
Kd 5.69%P/E Forward $63.94
WACC 7.71% Enterprise Value $132.75 Altman Z-score 5.39 M/B $50.15 Intrinsic Valuations Discounted Dividends $65.69 Free Cash Flows $76.85 Residual Income $31.52 Abnormal Earnings Growth $68.88
UPS Financial Valuation James Ward, Mark Childers, Larry Abney, Josh Wayman
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Fairly Valued Recommendation: Hold
Company, Industry Overview Analysis
UPS is the world's largest package delivery company, in terms of
revenue and volume. They were founded in 1907 as a private messenger and
delivery service in Seattle, Washington, and they celebrate their 100th
anniversary as a package delivery service this year. The future for the industry is
bright for several reasons; the globalization of trade, the increase in direct-to-
consumer shipments, and the movement of firms outsourcing their supply chain
management. The other big players in this industry include FedEx, and DHL.
FedEx is by far the most direct public competitor of UPS. While other firms
compete with UPS in some business segments, FedEx competes with UPS in
almost every segment of their business. Recently, package delivery companies
have become incredibly competitive on both aspects of price competition and
customer service. Not only does UPS focus on these two vital factors to be
successful, they turn to product differentiation, global reach, and market
penetration. While doing this, they thrive to improve cash flow and create
competitive advantages for the company.
Accounting Analysis
A company’s 10-K is essential to an accounting analysis. The 10-K is
released at every fiscal year end, the 10-K includes all the financial data for a
firm for the past year. When they analyze these financial statements, they do it
through the use of several ratios. Along with the ratios, we thoroughly read
through all relevant information to get a feel for the accounting strategy and
level of disclosure for UPS. Overall, we have found UPS does a great job
providing investors with valuable insight into the firms operations through quality
accounting disclosure. Furthermore it seems as though over the 100 years of
establishment for UPS, they have figured out how to run a company without
cutting corners. After reviewing all diagnostic ratios everything seems to be in
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order; there are not obvious red flags. We feel that UPS is not manipulating their
financial data.
Financial Ratio Analysis
The various ratios used in analyzing UPS included liquidity, profitability,
and capital structure. These ratios helped us determine where UPS is as a
company in relation to its main competitors. We used five ratios under our
liquidity analysis. These ratios can give a guideline on how the firm is turning
their assets into cash. These ratios are also vital in determining if the firm can
meet short and long-term debt obligations. These ratios included current ratio,
quick asset ratio, accounts receivable turnover, inventory turnover, and working
capital turnover. We used six ratios under our profitability analysis. These ratios
are also very important because it gives an inside look at profits with UPS in
comparison to the industry average. The ratios used were gross profit margin,
operating expense ratio, net profit margin, asset turnover, return on assets, and
return on equity. While analyzing these ratios, it is easy to see that a high
percentage on profit ratios is desirable. This in turn means the company is
efficient. While comparing UPS to the industry average, they seem to have a
dominant hold on profitability. Under capital structure analysis, it was necessary
to include only three ratios. These included debt to equity, times interest earned,
and debt service margin. The ratios used here basically tell where the firm got
the finances used to obtain their assets.
Valuation of Firm
After analyzing the valuation models, we found that UPS is fairly valued.
All models were included in the analysis except for residual income. We also
omitted some of the comparables because they were significantly off. This is due
to this model not being very explanatory. The model kept showing that the
residual income was consistently beating the cost of equity, which is impossible.
In turn, we had to use negative growth rates to offset this, which ultimately gave
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us a very low value of UPS. UPS came out to be worth about $70.47, compared
to the market value of $70.10, which is very close. Since almost every model was
consistent except for the residual income, we recommend a hold strategy.
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UPS
United Parcel Service is the largest freight and shipping operation in the
United States and second to only DHL in the world. They have recently begun to
move some of the services into the supply chain management of many
companies who are looking for a better way to manage their inventory. Their
main base of operations is located in Atlanta, Georgia at a 735,000 square feet
facility (UPS 10k). They also have major hubs in Louisville, KY; Columbia, SC;
Dallas, TX; and Philadelphia, PA just to name a few.
UPS believes that the future for the industry is bright for several reasons;
the globalization of trade, the increase in direct-to-consumer shipments, and the
movement of firms outsourcing their supply chain management.
With many trade barriers being eliminated and the once smaller markets
like China and India growing at a very high rate, we see the global market for
UPS as a excellent opportunity for expansion of their global market position.
Their global network is one of the biggest in the industry, and it is the only
network in the industry that uses express, ground, domestic, international,
commercial, and residential services though one pickup and delivery company.
To UPS this is very distinct competitive advantage because of a customer’s ability
to choose how, when and where they ship their packages is something that UPS
can offer to customers that competitors cannot effectively offer. With their global
network being one of the biggest this is an excellent opportunity for a rapid
expansion and growth over the next several decades. This is also one of the
most volatile markets with changes in these areas affecting most of the globes
business.
With the increase in just-in-time inventory and the much increased use of
Internet for ordering products, UPS sees direct-consumer shipments will continue
too sustain the increase it has experienced over the past few years. With the
largest fleet in the industry of nearly 98,000 vehicles they have the ability to
cover all business and residential areas in the contiguous U.S., making direct-
consumer shipments easier for them to compete on with their competitors.
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One the biggest areas of growth in the industry is by far the movement of
firms from having a company owned distribution center too outsourcing their
supply-chain management to companies like UPS. For instance a lot of firms
have their suppliers ship products too a distribution center, where that company
then has too take all the products organize them per store load onto another
truck, where you then could have multiple stores packages on one truck. This
process leads to a delay in products arriving at stores much later then when they
are needed. When a company outsourcers their supply chain they have the
ability to order directly from the supplier and it is then shipped to the store, so
that it ends up in the store it belongs, when it needs to be there.
The industry of package delivery and supply chain solutions is very bright
and this is why UPS sees their advantages in these areas over the rest of the
industry as an excellent opportunity. This is why they feel they have an excellent
chance to jump ahead and separate themselves from the competition.
Industry
United Parcel Service is in an ever-increasing competitive industry of
package delivery and supply chain management. The Industry is very
competitive, especially in package delivery. UPS competes on all levels, from
internationally, domestic and even regionally, all with different competitors on
each level.
Fed Ex, which is their top competition, has roughly 25% of the market
that number has stayed quite steady over the past few years with their growths
being almost parallel with each other. It is one of the only countries that is based
domestically and competes with them on every level, even international shipping
and supply chain management.
The rest of the market is made up of several fairly large companies and
many smaller ones. A few of them are Conway, TNT, and YRC Worldwide; these
three companies combined makes up roughly 16% of the market. There revenue
can tend to be more sporadic then the bigger companies, changing from heavy
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growth one year to losses the next. This might be due to some questionable
accounting or just they are smaller and do not have quite the stability that the
larger companies posses.
DHL, another one of their main competitors was only an international
opposition until they acquired Airborne Express. They have since grown very
heavily in the American market, lessening the market share of UPS. DHL which is
a subsidiary of Deutsche Post World Net, who some consider having almost a
monopoly over the European market with their other subsidiary Postbank. Since
DHL is a foreign-based company they do not have to submit the same
information as the domestically based companies. This made finding some of the
data quite challenging.
Products
UPS offers a wide variety of products and services, ranging from and
online site receives more than 145 million hits and processes over 10 million
package tracking transactions daily, all the way to having the most extensive
domestic and international package delivery service (UPS 10k). UPS has many
electronic services like UPS Worldship®, which helps streamline shipping
activities by performing many tasks needed in a company shipping activities all
from a desktop computer (UPS 10k). It allows UPS to connect to companies
order management software directly so that they can see what is needed,
keeping company employees from wasting much needed time filling out order
forms (UPS 10k). UPS also offers seven other electronic services that help
customers with their supply chain solutions.
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Sales Volume and Growth
In 2005 UPS had total revenue of $42.5 billion dollars, which was up from
$36.5 billion in 2004 or 16%. Over the past five years the revenue has steadily
increased by 40%, from 30 billion dollars to where it is now. UPS main
competitors FedEx Inc. over the same period has increased by almost 50%, from
19.6 billion in 2001 to 29.3 billion in 2005.
As you can see from some of our charts UPS has a dominant hold on the
industry’s market share with Fed Ex behind them and both of these companies
have roughly the same amount of growth over this period. With Conway losing
some of the market share and Yellow RC, a freight carrier firm, gaining some of
the market share. The steady growth over time belongs to the two main players
in UPS and FedEx.
Total Asset Value
When looking the asset values of UPS’s competitors we can separate out
some of the companies that do not compete on the same level with UPS.
Domestically only Fed Ex is any where near being on the same level with UPS.
The other three companies; Conway, Yellow RC, and TNT do not have the assets
to keep up on the national level with firms such as UPS and Fed Ex.
Fig 1.1 Total Assets
2001 2002 2003 2004 2005 UPS $24,636 $26,357 $28,909 $33,088 $35,222 Fed Ex $13,392 $13,812 $15,385 $19,134 $20,404 Conway $2,990 $2,739 $2,773 $2,496 $2,459 Yellow RC $1,286 $1,043 $3,463 $3,627 $5,734 TNT $8,454 $8,266 $7,915 $8,229 $8,396
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Market Capitalization and Stock Price
UPS has a market capitalization of 79.62 billion dollars compared to the
mkt. cap of Fed Ex at 35.21 billion. Historically UPS stock price has performed at
a steady pace (as shown below in Fig 1.2). As of February 2nd, 2007 the stock
was trading at $74.17 per share.
Fig 1.2
Sales Volume and Growth
In 2005 UPS had total revenue of $42.5 billion dollars, which was up from
$36.5 billion in 2004 or 16%. Over the past five years the revenue has steadily
increased by 40%, from 30 billion dollars to where it is now. UPS main
competitors FedEx Inc. over the same period has increased by almost 50%, from
19.6 billion in 2001 to 29.3 billion in 2005. Figures 1.3 and 1.4 illustrate the Sales
Revenue and Percentage growth of UPS and its main competitors.
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UPS 10
Fig. 1.3
Revenue
$-
$5,000
$10,000
$15,000
$20,000
$25,000
$30,000
$35,000
$40,000
$45,000
2001 2002 2003 2004 2005
In M
illio
ns UPS
FedEx
Conway
Yellow RC
Fig 1.4
Percentage Growth
-60%
-40%
-20%
0%
20%
40%
60%
80%
100%
120%
140%
2002 2003 2004 2005
UPSFedEXConwayYellow RC
As you can see from the above figures UPS has a dominant hold on the
industry’s market share with Fed Ex behind them and both of these companies
have roughly the same amount of growth over this period. With Conway losing
some of the market share and Yellow RC, a freight carrier firm, gaining some of
the market share. The steady growth over time belongs to the two main players
in UPS and FedEx.
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Five Forces Model
Rivalry Among Existing Firms
United Parcel Service (UPS) is located in an industry that is experiencing
steady growth from the firms that are already competing against them.
According to BusinessWeek the largest area of growth for the industry is in
international shipping and freight. The industry depends heavily on the health of
the United States economy. Declines in the market can lead to less shipping as
companies try to trim their costs. UPS has also diversified its business by
acquiring Overnight Transportation to expand into the Less than truckload (LTL)
freight business. While the industry gets more competitive firms are continually
trying to differentiate themselves.
Competitors
Since UPS operates in many different areas of the freight business they
have different competitors for each segment of their business. In the package
delivery business two of their three biggest competitors are not publicly traded
companies. The United States Postal Service is a government-owned corporation
and it competes with UPS on low cost shipping of packages. Another main
competitor that is also not publicly traded is Dalsey, Hillblom and Lynn
International (DHL). DHL is owned by Deutsche Post and through its acquisition
of Airborne Express it has emerged as one of UPS’ biggest competitors. UPS’
biggest public competitor is Federal Express (FedEx). FedEx competes with UPS
in almost every segment of their business. They are a major competitor in parcel
delivery, LTL, courier services, logistics and business services. FedEx often
responds to UPS’ moves in the industry. For example FedEx acquired Roadway
Package System to compete in ground delivery and acquired Kinkos to compete
against the UPS acquisition of Mail Boxes Etc. (MBE) in business services. UPS’
also has competitors in the LTL segment. Its biggest LTL competitors are FedEx,
Con-way Inc. and YRC Worldwide Inc. In its business services segment The UPS
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Store (formerly MBE) competes against FedEx Kinkos and many small
independent outlets such as PostNet and Pakmail. UPS has a high concentration
of competitors in some segments such as LTL and business services but faces
just a few rivals in its main package/parcel shipping service. UPS is in a mixed
competition industry where it has to keep its prices low while differentiating itself
from its competitors.
Differentiation and Switching Costs
Since UPS is an industry that has few competitors it must rely on
differentiation to distinguish itself from others. It also has the disadvantage of
competing against the government-owned USPS that is subsidized and therefore
can conduct business cheaper. One of UPS biggest strengths over its competitors
is its size. UPS has a ground fleet of over 98,000 vehicles, which is over double
the size of FedEx. UPS also has the most extensive international shipping service.
It is the only firm to provide all of its services on an international level. On a cost
leadership level UPS uses its extensive experience in the industry to have on of
the most efficient system of shipping packages. Switching costs are high in the
industry due to cost of vehicles, airplanes, airport hangers, etc. This makes it
difficult for a company to compete in another segment of the industry without
acquiring a company that already serves that segment.
Ratio of Fixed to Variable Costs
UPS operates within an industry where high fixed costs are prevalent. UPS
owns about half of their aircraft while the other half is either leased or chartered
from air carriers. UPS owns most of their ground fleet and almost all of their
facilities. Because of the high fixed cost that UPS carries they have to streamline
their operations to keep their variable costs to a minimum. UPS uses a system
called hub and spoke to keep efficient movement of packages. UPS has several
large hubs located across the United Stated and throughout the world. UPS has
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UPS 13
also used technology to move packages through their facilities faster. Their
Worldport facility in Louisville, KY can sort over 300,000 packages per hour. To
be successful in this industry firms like UPS have to maintain a low variable cost.
Excess Capacity and Exit Barriers
Since UPS operates in an industry that provides a service rather than a
product its excess capacity is the facilities, aircraft, vehicles, etc. For the most
part they are able to use their capacity in an efficient way. However if there were
a significant downturn in the economy or a disaster they would have a hard time
making use of the excess capacity or even selling it off. There are significant exit
barriers in this industry since the equipment is very specialized and costly. This
has made it hard for the smaller regional firms to compete with UPS.
Threat of New Entrants
Economies of Scale
Economies of Scale are a huge part of the shipping industry. It takes a lot
of capital to build up a network large enough to compete with other firms.
Smaller regional firms would have to a huge influx of capital to expand their
business to even a national scale. It is cheaper for UPS to operate larger facilities
that process a large volume and then send these to the smaller facilities. This is
a key component of the hub and spoke system. The only way a new firm could
viably enter the market is by assembling a group of regional firms. The huge
fixed assets on the balance sheet make this a hard industry to enter.
First Mover Advantage
In the shipping industry there is a distinct first mover advantage. UPS has
taken advantage of this by having a ground fleet long before their biggest rival
FedEx. Since they have had the time to build up such a large fleet they are able
to reach more areas especially the rural ones and keep costs low. There is also a
distinct first mover advantage in the international segment. Since flights are
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UPS 14
regulated by government entities it takes a significant amount of time to get
permits to fly into international airports. Countries like China have made it
difficult since they restrict the amount of foreign involvement in their country.
Since China represents a huge growth opportunity it is important to get into the
country first. The First Mover Advantage is significant for UPS.
Channels of Distribution and Relationships
Channels of Distribution are somewhat different in the shipping industry.
Since UPS like FedEx is a vertical industry they are fairly autonomous. They
handle all parts of the shipping process. However UPS uses over 7000
independent retailers to sell their service for them. They must keep good
relationships with these retailers so that they will recommend UPS chipping to
their customers. UPS has to uphold their schedule of package pickup/delivery
from these retailers to keep them as sellers of the UPS service.
Legal Barriers
UPS has many legal barriers. Since they operate a transportation company
they must comply not only with regulations and licenses from the USDOT and
FAA but they must also comply with international, state, and local laws regarding
transportation. They must also pay for insurance on all their vehicles and aircraft.
UPS has to also deal with the Teamsters labor union. UPS rarely has to deal with
the cost of copyrights and patents.
Threat of Substitute Products
In the shipping industry there are few choices for customers. Most
customers have the choice between USPS, UPS, FedEx, DHL and sometimes
some regional carriers. Because of this customers could easily switch from one
company to another. In order for UPS to keep customers it must differentiate
itself from the other companies and make the extra price worth the service. The
UPS brand is a huge part of their success. UPS is known for their superior
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UPS 15
customer service and their impeccable safety record. Another advantage that
UPS has over substitute products is their delivery. UPS is constantly adding more
options to deliver packages. As seen on a current advertising campaign UPS is
delivering packages to locations earlier than most other carriers. UPS’ large
global footprint also helps it get packages to some areas that otherwise would be
impossible or costly. The biggest threat of substitute products is USPS. USPS is
subsidized by the US government and therefore is able to ship packages cheaper
than the other carriers.
Bargaining Power of Buyers
As noted earlier customers have a handful of options in the shipping
industry. Price sensitivity varies on the type of customer and UPS has realized
while it cannot be the low cost leader it must keep prices under control. Since
this industry is not as price sensitive the customers have a huge amount of
bargaining power. The bargaining power that customers possess makes it so that
all the companies in the industry must constantly be adding more convenience,
better service, and new ways of doing things. UPS has used this to its advantage
by leading with superior customer service that the customer would not be able to
find at the post office. UPS also has responded by adding new services and is
always working to make their services more useful to businesses.
Bargaining Power of Suppliers
UPS and the Shipping industry are unique in the fact that it can control
most of the pricing on its products. The biggest costs that the industry incurs are
the price of fuel, labor, and packing supplies. UPS is very dependent on the price
of fuel, which is very volatile. UPS can get bulk discounts on fuel and it can buy
fuel options but beyond that it doesn’t have much control over its suppliers on
price. Many external factors such as natural disasters, terrorism, and politics play
a huge part of the price of fuel. When it comes to labor UPS has been fairly
successful with dealing with the union and avoiding the problems that have
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UPS 16
plagued the US auto industry. For letter envelopes and small boxes UPS has a
wide variety of companies it could purchase these products from. On its fixed
assets UPS is lucky that the industry is very competitive and that there are
always price wars on airplanes and vehicles.
Competitive Advantage Analysis
Recently, package delivery companies have become incredibly competitive
on both aspects of price competition and customer service. Not only does UPS
focus on these two vital factors to be successful, they turn to product
differentiation, global reach, and market penetration. While doing this, they
thrive to improve cash flow and create competitive advantages for the company.
In an industry such as this, there are very few competitors so the main goal of a
company is primarily to focus on differentiation, but still keeping cost in mind. By
fully analyzing different competitors in the industry, we will be able evaluate this
company more efficiently and see exactly what UPS does to create value for the
company while maintaining positive customer relations. UPS, which first started
as a small delivery service in Seattle, Washington in 1907, has gained
tremendous growth over the years, delivering packages to over 1.8 million
people every day in over 200 countries. They have now become the largest
package delivery company in the world. When trying to differentiate a company,
it is very vital that the company grasps a competitive edge by developing unique
products or flexible services. We found that UPS uses a variety of techniques and
innovative approaches to gaining an edge. In this particular industry, competing
on price and time are key elements for success. One example of how UPS goes
about doing this is called the UPS Next Day Air. This is the most recent approach
in trying to improve time efficiency to customers. This certain approach
guarantees a customer delivery by the next day on or before 10:30 a.m. UPS
guarantees this certain time for an immaculate 75% of the United States
population. 15% will come on or before noon the next day. No other company
has developed this yet. Ultimately, this particular service creates value for the
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UPS 17
company by continuing to build on long-term relationships with customers. A
main focus of UPS in the near future is to continue to expand internationally.
Since the market for international delivery is growing at a fast pace, it is
important for UPS to keep and maintain a strong presence globally. There are
many locations they would like to expand in, but two specific areas UPS would
like to focus on are India and China, since these two countries will be the largest
consumer markets in the next 25 years. As stated above, UPS will continue to
differentiate themselves by continuing their global reach. What gives them a
competitive advantage over their main competitor, FedEx, is the sole fact that
UPS has a much bigger air and ground fleet. They operate over 98,000 UPS
vehicles and are the 9th largest airline in the world. In addition, there are 5,600
UPS stores. Compare that to the 1,300 FedEx Kinko’s stores and it is evident that
their reach is by far more superior. Outlooks for both companies are very similar,
with FedEx traditionally following similar moves of UPS, but it is UPS that is
pushing harder for more global reach. While FedEx is focusing mainly on China
and India, UPS is making efforts to Mexico, Canada, Puerto Rico, Guam, and the
Virgin Islands, as well as the prospective China and India. In a differentiated
market, superior customer service should be amongst the top key factors in
running a company. UPS provides just that. With over 20 billion dollars invested
in information technology over the last 20 years, UPS has allowed easy access
over the Internet to customer needs. A part of their success is the key principle
of customer satisfaction. UPS focuses on making customers more successful in
their career, which will in turn make UPS and successful. With innovative
techniques, an increased global reach, and superior customer service, UPS is in a
very mixed market, leaning more towards differentiation. With the very good
economic outlook, it is safe to say they will remain successful domestically and
internationally, holding the edge over competitors and maintaining long-term
relationships with customers.
UPS Financial Valuation James Ward, Mark Childers, Larry Abney, Josh Wayman
UPS 18
Key Success Factors
Recently, package delivery companies have become incredibly competitive
on both aspects of price competition and customer service. Not only does UPS
focus on these two vital factors to be successful, they turn to product
differentiation, global reach, and market penetration. While doing this, they
thrive to improve cash flow and create competitive advantages for the company.
Competitive Advantage Analysis
In an industry such as this, there are very few competitors so the main
goal of a company is primarily to focus on differentiation, but still keeping cost in
mind. By fully analyzing different competitors in the industry, we will be able
evaluate this company more efficiently and see exactly what UPS does to create
value for the company while maintaining positive customer relations. UPS, which
first started as a small delivery service in Seattle, Washington in 1907, has
gained tremendous growth over the years, delivering packages to over 1.8
million people every day in over 200 countries. They have now become the
largest package delivery company in the world. When trying to differentiate a
company, it is very vital that the company grasps a competitive edge by
developing unique products or flexible services. We found that UPS uses a
variety of techniques and innovative approaches to gaining an edge. In this
particular industry, competing on price and time are key elements for success.
One example of how UPS goes about doing this is called the UPS Next Day Air.
This is the most recent approach in trying to improve time efficiency to
customers. This certain approach guarantees a customer delivery by the next
day on or before 10:30 a.m. UPS guarantees this certain time for an immaculate
75% of the United States population. 15% will come on or before noon the next
day. No other company has developed this yet. Ultimately, this particular service
creates value for the company by continuing to build on long-term relationships
with customers.
UPS Financial Valuation James Ward, Mark Childers, Larry Abney, Josh Wayman
UPS 19
A main focus of UPS in the near future is to continue to expand
internationally. Since the market for international delivery is growing at a fast
pace, it is important for UPS to keep and maintain a strong presence globally.
There are many locations they would like to expand in, but two specific areas
UPS would like to focus on are India and China, since these two countries will be
the largest consumer markets in the next 25 years.
As stated above, UPS will continue to differentiate themselves by
continuing their global reach. What gives them a competitive advantage over
their main competitor, FedEx, is the sole fact that UPS has a much bigger air and
ground fleet. They operate over 98,000 UPS vehicles and are the 9th largest
airline in the world. In addition, there are 5,600 UPS stores. Compare that to the
1,300 FedEx Kinko’s stores and it is evident that there reach is by far more
superior. Outlooks for both companies are very similar, with FedEx traditionally
following similar moves of UPS, but it is UPS that is pushing harder for more
global reach. While FedEx is focusing mainly on China and India, UPS is making
efforts to Mexico, Canada, Puerto Rico, Guam, and the Virgin Islands, as well as
the prospective China and India.
In a differentiated market, superior customer service should be amongst
the top key factors in running a company. UPS provides just that. With over 20
billion dollars invested in information technology over the last 20 years, UPS has
allowed easy access over the Internet to customer needs. A part of their success
is the key principle of customer satisfaction. UPS focuses on making customers
more successful in their career, which will in turn make UPS and successful.
With innovative techniques, an increased global reach, and superior
customer service, UPS is in a very mixed market, leaning more towards
differentiation. With the very good economic outlook, it is safe to say they will
remain successful domestically and internationally, holding the edge over
competitors and maintaining long-term relationships with customers.
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UPS 20
Accounting Analysis
The accounting analysis is important because it shows how a company
uses its resources. It is the instrument that the company uses to show how it
makes its decisions. It is important to study the accounting disclosure and
methods and compare it to that of it its competitors. The goal is to see a true
picture of the company. Each company can make decisions under the rules of
GAAP that can dramatically change the look of its financial health. It is important
to look deep into the accounting and evaluate the estimations and strategy that
the company uses.
Key Accounting Policies
It is important to identify the key success factors of UPS into the
information provided in their financial statements. UPS focuses on some main
competitive strategies. Their key success factors are product differentiation,
global reach, and market penetration. Since UPS does not have an inventory, we
will evaluate them with how they treat their long term assets. We will also see
how competitive they are on a cost basis.
Goodwill and intangible assets are considered a key accounting policy
since they have acquired companies recently as to vertically integrate the
company. Goodwill is the money paid when acquiring a company over and above
the book value of the company. Over the past 3 years UPS has acquired Menlo
Worldwide forwarding, Overnight Transportation, and Mail Boxes Etc. Because
of these acquisitions, UPS has had to deal with the impairment of goodwill. “We
use a discounted cash flow model to estimate the fair value of our goodwill”
(UPS 10-K 2005) UPS breaks up their goodwill by segment, and the highest
source of goodwill is in their Supply Chain and Freight segment, since this is the
segment most impacted by the acquisitions. UPS updates the impairments on
their goodwill yearly to keep it up to date. The DCF model that UPS uses to
impair their goodwill is good because it uses many variables to calculate the
UPS Financial Valuation James Ward, Mark Childers, Larry Abney, Josh Wayman
UPS 21
impairment. By doing it this way, they are able to more accurately state the fair
value of the goodwill they carry on their balance sheet.
UPS is unique in that it is an industry that does not use inventory, which is
a key accounting policy that most analysts use to value a company. Since UPS
does not use inventory, we will look at how they treat the costs of their long-
term assets. UPS has a huge investment in long-term assets represented by their
fleet of airplanes, delivery vehicles, and facilities. According to UPS they make
estimates on the useful life of their assets by using actual experience from past
assets. UPS capitalizes the leases they sign on aircraft they do not own, they also
use charter agreements for other planes. Aircraft makes up the largest of their
fixed assets and in total they have $15.289 billion in fixed assets. For their fleet
of vehicles UPS owns approximately half while operators own or lease the rest.
Also UPS owns a majority of their facilities. It is important to see that UPS owns
or capitalizes a majority of their assets. This shows that they are not trying to
hide their fixed assets off of their balance sheet.
UPS provides in its accounting a measure of its average daily volume of
packages. This information is important to see how much of a market share that
UPS has. But it is also important to see revenue per piece to see if UPS is
maximizing their revenues compared to their competitors. The only relevant
information available was from UPS and their biggest domestic competitor FedEx.
The first chart shows the average daily volume of UPS and FedEx from 2001
through 2005. First, it shows that UPS is the leader in the industry in the United
States. Secondly, it shows that both companies have been progressing pretty
similarly. Although FedEx has a noticeable jump in 2004, UPS has been growing
smoothly and has lost very little market share to FedEx. Figure 2.2 shows the
revenue per piece. The figure shows that FedEx has been able to get an average
of $14 per piece while UPS has been able to get about $10. A major reason for
UPS Financial Valuation James Ward, Mark Childers, Larry Abney, Josh Wayman
UPS 22
Fig 2.1
Average Daily Volume
0
2000
4000
6000
8000
10000
12000
14000
16000
2001 2002 2003 2004 2005
Volu
me
in th
ousa
nds
UPS FedEx
Fig 2.2
Revenue Per Piece
$0.00
$2.00
$4.00
$6.00
$8.00
$10.00
$12.00
$14.00
$16.00
2001 2002 2003 2004 2005
UPSFedEx
UPS Financial Valuation James Ward, Mark Childers, Larry Abney, Josh Wayman
UPS 23
this is because FedEx is the leader in air shipments of overnight deliveries. This
segment is more profitable since consumers are willing to pay more money for
this service. UPS has however been steadily increasing while FedEx has stayed
relatively flat. Both companies compete with each other on the same products,
however each company has some products that they do better than their
competitors. The reasoning behind this is that UPS is growing their overseas and
overnight segments.
Accounting Flexibility
GAAP is the rules that determine how a company must report it
accounting. By having GAAP it makes it easy to compare companies and sets
rules for companies to follow so that outsiders can get a fair and true look at the
company’s financial health. However, within GAAP, companies can use the
flexibility to distort the finances to make it look better to investors. Since there is
flexibility in how GAAP can be applied, we must look and see how flexible UPS is.
UPS is fairly conservative in their financial reporting. For example, in the
shipping industry fixed assets are a huge part of the businesses. As discussed
earlier UPS owns most of their fixed assets however the assets that UPS doesn’t
own, it uses capital leases. By capitalizing the fixed asset, it has a corresponding
liability for the life of the asset. They could reduce their liabilities by making the
leases operating leases but they choose not to as to give a better picture of the
company.
UPS uses a DCF model to determine the fair value of their goodwill so that
the figures they give are more accurate. This is industry standard in reporting
goodwill. It also gives a more accurate value of goodwill opposed to
amortization. This is more relevant to UPS as they are involved in more
acquisitions compared to their competitors. As of December 31, 2005 UPS had
goodwill of $2.5 billion and they recorded no impairment on this goodwill from
2003-2005 (UPS 10K, 2005).
UPS Financial Valuation James Ward, Mark Childers, Larry Abney, Josh Wayman
UPS 24
One place where UPS is somewhat aggressive is in their reporting of
Pension liabilities and postretirement medical benefits. UPS uses assumptions to
predict these liabilities. Even though UPS calculates these assumptions using
data relevant to these liabilities, there is still room for management estimates.
While UPS says they use relevant information to calculate the pension expense,
its competitor FedEx explains all the numbers used in calculating its pension
expense. This could allow UPS to target estimates based on the performance of
the company. In 2005 UPS recorded a pension benefit cost of $194 million with a
discount rate of 6.09% and a postretirement medical benefit cost of $248 million
and a discount rate of 6.25% (UPS 10K, 2005) While the postretirement medical
benefits have been increasing steadily the pension benefit costs have seen a high
degree of volatility in the past three years. This could be attributed to the
assumptions they use in estimating these liabilities.
As a whole, UPS is conservative in their accounting; they use very few
aggressive measures in reporting. Most of their methods are based on specific
equations that they have created based on past performance of not only their
company but also the industry. Even aggressive measures that they use have
some basis on past performance. This reduces the opportunity for the corporate
managers to try and manipulate the numbers. UPS has also been consistent in
the way apply GAAP to their reporting over the last five years.
Actual Accounting Strategy
The type of accounting strategy a company uses is very vital in
determining where the company is going in the future and how successful they
can remain. By maintaining certain accounting strategies, one company can
compare themselves to another. This in turn will help a company see the flaws
and point out the necessary adjustments that will need to occur. After evaluating
UPS, we considered them to have a conservative accounting approach. They
show their actual financial position at the time, completely disclosing all financial
information, rather then hiding it from outsiders.
UPS Financial Valuation James Ward, Mark Childers, Larry Abney, Josh Wayman
UPS 25
UPS adopted the measurement provisions of FAS 123 and No. 148. Under
this provision, all stock-based compensation will be expensed at fair value. In
turn, this increases UPS’s expenses and therefore decreases the company’s net
income bottom line. Recently the FAS 123 was replaced by the FAS(R) 123,
which is the “Shared-Based Payment,” a revision of the original FAS 123.
UPS depreciates its fixed assets on a straight-line over the useful lives.
Their depreciation expense has increased to 6.5% from the previous year due to
acquisitions in aircraft and buildings. This will continue to grow as the company
grows in the near future. By depreciating the fixed assets on a normal basis,
allowance for later write offs and the possibility of earnings management are not
apparent.
Both UPS and FedEx are very similar when reporting the appropriate
accounting numbers. Since both companies are service companies, they report
fixed-assets very similarly in their statements. Also, revenue is recognized for
both companies when the shipments are delivered or the percentage of
completion method, which is the shipments that have been picked up, but not
yet delivered to the customer. One difference between the two companies is the
way they treat their main asset, aircraft. FedEx depreciates aircraft on a 15-18
year basis while UPS depreciates it on a 12-20 year basis.
Quality of Disclosure
Accounting rules and regulations require a certain amount of disclosure.
The firm’s quality of disclosure rests in the hands of management. Managers
have the ability to make it more or less easy for analysts to gain an
understanding of the firm’s accounting quality. High quality disclosure allows an
analyst to gain a clear picture of a firm’s inner workings. Fully understanding
how a firm operates is essential to determining the value of a firm. Disclosure
includes footnotes, management’s discussion, information about current activities
and past performance, and a vision for the future.
UPS Financial Valuation James Ward, Mark Childers, Larry Abney, Josh Wayman
UPS 26
With regards to footnotes we found that UPS provides a great deal of
valuable information to investors, which allows a proper assessment of their
business strategy. They explain key accounting policies and assumptions in great
detail. Each and every segment of UPS is broken down and explained clearly and
individually.
While some firm’s use the Letter to the Shareholders in their annual
reports to merely make the firm look good, we feel that UPS clearly discusses
current and past performance, the industry conditions, and gives us a clear plan
for future growth. This is done by discussing performance and growth figures, as
well as this past year’s accomplishments.
UPS uses their management discussion and analysis section to clearly
present performance and change figures. Along with this figure presentation they
clearly explain reasons for the performance changes in each segment. Overall we
have found UPS does a great job providing investors with valuable insight into
the firms operations.
Potential Red Flags
When going over the financial statements and notes to financial
statements, for UPS it seems as though over there 100 years of establishment
they have figured out how to run a company without cutting corners. Nothing
appeared to jump out at us while going over these documents. The discount rate
they use on their pension expense is 5.75%, which is actually a little lower than
the industry standard. Even when you run the revenue and expense diagnostic
ratios, UPS’s numbers come out to be steady over the previous five years. When
there is a spike or something that may resemble a warning sign the next year it
is right around the area it was before. Over the next few sections we will go over
and discuss these diagnostic ratios.
UPS Financial Valuation James Ward, Mark Childers, Larry Abney, Josh Wayman
UPS 27
Revenue Diagnostics Ratios
Net Sales/Cash from Sales
This ratio helps determine how much of the sales are from cash and not
paid on credit. An increase in this number, which means the firm is selling more
on credit and less on cash, can be a caution flag. So for UPS in 2001 for every
$1.16 they had in revenue it was backed by $1 in cash. Over the five year period
UPS’s number did not change much if any and the same is too say for the two
other major competitors Fed Ex and DHL, except for a small increase in DHL’s
ratio in 2005.
2001 2002 2003 2004 2005 UPS 1.16 1.14 1.14 1.16 1.16 Fed Ex 1.14 1.13 1.14 1.13 1.12 DHL 0.84 1.18 1.16 1.17 1.23
Net Sales/Cash from Sales
0.00
0.20
0.40
0.60
0.80
1.00
1.20
1.40
2001 2002 2003 2004 2005
UPS
Fed Ex
DHL
UPS Financial Valuation James Ward, Mark Childers, Larry Abney, Josh Wayman
UPS 28
Net Sales/Accounts Receivables
This ratio shows the relationship between Sales and Accounts Receivables,
for example in 2005 for every $7.16 of Sales, UPS had $1 in accounts
receivables. The industry has a pretty standard ratio of around 7-9, and all three
companies stay near this range. With this and the previous discussed ratio shows
that most of revenue in the industry is backed by cash and not credit. This is
good because with credit you can have a problem with collecting.
2001 2002 2003 2004 2005 UPS 7.44 8.33 8.36 7.10 7.16 Fed Ex 8.27 8.56 8.16 8.91 9.18 DHL 6.91 6.57 7.30 6.86 5.44
Net Sales/Accounts Receivables
0.00
1.00
2.00
3.00
4.00
5.00
6.00
7.00
8.00
9.00
10.00
2001 2002 2003 2004 2005
UPS
Fed Ex
DHL
Expense Diagnostic Ratios
Asset Turnover
Total sales over total assets is the asset turnover ratio, it measure the
ratio of sales to assets. The range that most companies strive to achieve with
this ratio is between .8 - 1.29, this is because you do not want to have many
UPS Financial Valuation James Ward, Mark Childers, Larry Abney, Josh Wayman
UPS 29
assets not backed by sales and vice versa. If you have assets that are not
backed by sales then that means that you are not being efficient with your
assets. As the numbers and the graph show UPS has been in this range over the
past 5 years, showing a solid and impressive trend. While both Fed Ex and DHL
have ventured out of this range on several occasions, they have primarily stayed
near it if not in it.
2001 2002 2003 2004 2005 UPS 1.23 1.19 1.16 1.11 1.21
Fed Ex 1.17 1.46 1.29 1.44 1.42
DHL 2.14 1.57 1.54 1.52 1.25
Sales/ Assets
0.00
0.20
0.40
0.60
0.80
1.00
1.20
1.40
1.60
1.80
2001 2002 2003 2004 2005
UPS
Fed Ex
DHL
CFFO/OI
Another helpful expense ratio is the cash flow from operations over the
operating income. This ratio will help to detect if the firm might be trying to hide
UPS Financial Valuation James Ward, Mark Childers, Larry Abney, Josh Wayman
UPS 30
some major expenses, if this ratio has a major decrease it would inspire a look at
the numbers and books to see if there is something there. After running the
numbers and looking at them you might want to say that there is a big loss from
2002 to 2003, but when you look at the UPS 2002 10k and look at the statement
of cash flows. You see a change in the vacation policy and a tax reversal that
together totals 898 million dollars. This increases the CFFO for 2002, then it goes
back to right around 1 for the next 3 years.
2001 2002 2003 2004 2005 UPS 0.98 1.39 1.03 1.07 0.94 Fed Ex 1.69 1.27 2.10 1.26 1.22 DHL 1.32 1.45 1.13 0.78 0.95
CFFO/OI
0.00
0.50
1.00
1.50
2.00
2.50
2001 2002 2003 2004 2005
UPSFed ExDHL
CFFO/NOA
The final expense ratio for UPS is cash flow from operations over net
operating assets. This ratio can show a firm trying to hide some of their
expenses in their assets on the balance sheet. A decline in this ratio will usually
UPS Financial Valuation James Ward, Mark Childers, Larry Abney, Josh Wayman
UPS 31
lead to a question about the capitalization of expenses practice. As you can see
though again UPS is pretty steady having the least amount of overall change out
of their two main competitors, starting at .51 in 2001 and ending at .53 in 2005.
2001 2002 2003 2004 2005
UPS 0.51 0.65 0.46 0.42 0.53
Fed Ex 0.61 0.47 0.61 0.59 0.57
DHL 0.45 0.32 0.26 0.19 0.32
CFFO/NOA
0.00
0.10
0.20
0.30
0.40
0.50
0.60
0.70
2001 2002 2003 2004 2005
UPSFed ExDHL
After reviewing the diagnostic ratios there is nothing that leads us to any
concern. Within all the ratios UPS was either in the good range for that ratio or
was improving to a better ratio. This shows that UPS is not manipulating their
financial data to make it seem better than it really is. It is important to make
sure that there are no manipulations in the financial data so that investors will
feel confident in investing in the company.
UPS Financial Valuation James Ward, Mark Childers, Larry Abney, Josh Wayman
UPS 32
Financial Analysis
The main idea of this section is to financially analyze UPS, which means
we will be using financial data to evaluate the current and past performance of
UPS (Business Analysis and Valuation, pg. I-8). The analysis will use several
different analysis tools including but not limited to cash flow and ratio analysis. It
is key to be correct and effective on this section because a small change in the
numbers can be huge when it comes to deciphering what the numbers mean.
Ratio Analysis and Forecast Financials
In this next section of our analysis of UPS, we will be working through a
number of ratios using financial data gathered from the past five actual years.
This will allow use to take a closer look at past and present performance of UPS
individually. We will then perform the same ratio analysis on competing firms to
gauge how UPS stands in comparison to the competition as well as the industry
average. Once this information is gathered we will then use it to make the best
estimation of future performance for the next 10 years. This type of analysis is
important because it allows us to take a closer look at the firms past
performance, and this will help us in determining where the firm will go in the
future.
Trend Analysis
We will begin by performing a trend analysis. This is necessary to gain
insight into to the firm and the industry as a whole, this will allow us determine
the trends of both. Analyzing past and present performance and determining
trends will allow us to better estimate how the firm and industry will perform in
the future. The trends analysis will be broken down into three categories;
liquidity, profitability, and capital structure.
Liquidity
Liquidity ratios are used to determine of how liquid a firm is, this means
how easily the firm can convert assets into cash. These ratios are important
when determining a firm’s ability to meet its long and short term debt
UPS Financial Valuation James Ward, Mark Childers, Larry Abney, Josh Wayman
UPS 33
obligations. We will be using five ratios to determine liquidity; the current ratio,
the quick ratio, receivables turnover, days outstanding, and working capital
turnover.
Current Ratio UPS FDX DHL Industry Avg.
2001 1.64 1.08 1.02 1.25 2002 1.57 1.25 1.01 1.28 2003 1.79 1.18 1.02 1.33 2004 1.93 1.03 1.09 1.35 2005 1.62 1.11 1.06 1.26 Current Ratio= Current Assts/Current Liabilities
The current ratio is determined by using two numbers that can be found
on the company’s balance sheet, current assts and current liabilities. The current
ratio is primarily used to determine a firm’s ability to pay off its short-term debt.
The higher the ratio the more capable the firm is to pay off debt. A ratio of less
than one would be the firm is not capable at that point in time. This ratio states
the amount of current assets the firm holds in comparison to every dollar of
current liabilities.
Current Ratio
0
0.5
1
1.5
2
2.5
2001 2002 2003 2004 2005
Years
Out
put
UPSFDXDHLIndustry Avg
UPS Financial Valuation James Ward, Mark Childers, Larry Abney, Josh Wayman
UPS 34
The graph above gives us a visible representation of the competitions
performance as well as the industry average. This gives us a basis for
comparison to UPS. Over time UPS has steadily increased their current ratio, with
an exception in 2005 with a slight decrease. Overall UPS has a favorable current
ratio, which tells us that they are capable of covering their short-term debt
obligations. The industry maintained a stable slightly increasing current ratio.
When compared to the industry UPS has shown its ability to maintain a higher
level of liquidity over the past five years.
Quick Ratio UPS FDX DHL Industry Avg.
2001 1.2 0.81 1.01 1.01 2002 0.98 0.96 1.00 0.98 2003 1.06 0.95 1.01 1.01 2004 1.55 0.85 1.04 1.15 2005 1.18 0.92 0.99 1.03
Quick Ratio= (Cash+Accounts Receivable+Securities)/Current Liabilities
The quick ratio is used to measure a company’s ability to meet its short-
term debt obligations with its most liquid assets. The quick ratio is slightly
different from the current ratio because it uses the firm’s most liquid assets and
not all current assets to determine liquidity. Like the current ratio the higher the
ratio the more capable the firm is to pay off debt. This ratio states the amount of
liquid assets the firm holds for every dollar of liabilities.
UPS Financial Valuation James Ward, Mark Childers, Larry Abney, Josh Wayman
UPS 35
Quick Ratio
0
0.2
0.4
0.6
0.8
1
1.2
1.4
1.6
1.8
2001 2002 2003 2004 2005
Years
Out
put
UPSFDXDHLIndustry Avg
Overall for the past five years the quick ratio for UPS has been above its
competitors and the industry average as a whole. This shows us that UPS has
greater ability to convert quick assets if needed to cover short-term debt. This
leads us to the conclusion that overall UPS has a favorable quick asset ratio for
the past five years, and will most likely continue this trend into the future. This
equates to a competitive advantage for UPS, they have greater ability to cover
debt than their competition and the industry.
Receivables Turnover UPS FDX DHL Industry Avg.
2001 7.44 5.44 6.91 6.60 2002 8.33 8.27 6.57 7.72 2003 8.36 8.56 7.3 8.07 2004 7.1 8.16 7.76 7.67 2005 7.16 8.91 5.5 7.19
Receivables Turnover= Revenue/Accounts Receivable Days Outstanding
UPS FDX DHL Industry Avg. 2001 49.06 67.10 52.82 56.33 2002 43.82 44.14 55.56 47.84 2003 43.66 42.64 50 45.43 2004 51.4 39.83 47.04 46.09 2005 51 40.97 66.36 52.78
Days Outstanding= 365/Receivables Turnover
UPS Financial Valuation James Ward, Mark Childers, Larry Abney, Josh Wayman
UPS 36
Accounts receivable is a measure of how much revenue is tied up because
it has not yet been collected. Accounts receivable turnover tells us how efficient
the firm is when it comes to collecting this outstanding revenue. In this case a
high ratio implies that the firm is efficient at extending credit and collecting of
their accounts receivable.
Days outstanding is a measure that allows us to determine how many
times a year the accounts receivable are collected. This is an important factor
because the longer accounts receivable are outstanding the more opportunity is
missed to reinvest revenue.
Receivables Turnover
0
1
2
3
4
5
6
7
8
9
10
2001 2002 2003 2004 2005
Years
Out
put
UPSFDXDHLIndustry Avg
UPS Financial Valuation James Ward, Mark Childers, Larry Abney, Josh Wayman
UPS 37
Days Outstanding
0
10
20
30
40
50
60
70
80
2001 2002 2003 2004 2005
Years
Out
put
UPSFDXDHLIndustry Avg
As you can see from the graph above, the receivables turnover for UPS
has been decreasing slightly for the past five years. From 2001 to 2003 UPS was
steadily increasing and held a position higher than the industry average and
above most competition. After 2003 UPS began a slight decrease and FedEx took
the lead. This tells us that in the past three years UPS has become slightly less
efficient when it come to collecting receivables. Overall UPS has mostly stayed
above the industry average and most competition. This leads us to believe that
UPS has a slightly unfavorable receivables turnover ratio, because of the decline
in most recent years.
The graph above shows us that over the past five years UPS has mostly
been collecting receivables fewer times per year than the industry average.
Overall the days outstanding has been on a positive slope. This is a good sign for
the future, but UPS has a ways to go to rise above the competition and the
industry average. The faster a firm is able to collect their receivables the more
liquid they are.
UPS Financial Valuation James Ward, Mark Childers, Larry Abney, Josh Wayman
UPS 38
Working Capital Turnover UPS FDX DHL Industry Avg.
2001 10.22 78.2 12.82 33.75 2002 9.82 28.5 20.51 19.61 2003 7.72 37.11 20.36 21.73 2004 6.02 151.6 3.67 53.76 2005 10.11 54.88 5.31 23.43
Working Capital Turnover= Revenue/(Current Assets-Current Liabilities)
Working capital turnover allows us to gain insight into a firm by
determining how effectively they use working capital to generate revenue. As
with the past liquidity ratios, we want a high working capital turnover. The
higher the ratio the more effectively a firm is generating revenue from the capital
used to generate revenue.
Working Capital Turnover
0
20
40
60
80
100
120
140
160
2001 2002 2003 2004 2005
Years
Out
put
UPSFDXDHLIndustry Avg
As you can see from the graph, the working capital turnover for UPS is
stable. Although it is stable it is obvious that that UPS is not operating as
efficiently as the industry. This means that the money UPS is investing in
operating capital is not paying off as well as the industry.
UPS Financial Valuation James Ward, Mark Childers, Larry Abney, Josh Wayman
UPS 39
Liquidity Analysis
2001 2002 2003 2004 2005 Opinion Current Ratio 1.64 1.57 1.79 1.93 1.62 Positive
Quick Ratio 1.2 0.98 1.06 1.55 1.18 Positive Receivable Turnover 7.44 8.33 8.36 7.1 7.16 Slightly
NegativeDays Outstanding 49.06 43.82 43.66 51.4 51 Slightly
NegativeWorking Capital Turnover
10.22 9.82 7.72 6.02 10.11 Negative
In conclusion, UPS’s liquidity could become a problem if for some unseen
future reason it needed to liquidate its assets. This is not a major problem, due
to the fact that just because they are not highly liquid does not mean that they
do not have some liquidity. A reason why they are not that liquid is because a lot
of their assets are tied up in the vehicles, which are a major part of their
industry. They could increase their liquidity by holding a little more cash on hand.
PROFITABILITY RATIOS:
In general the profitability ratios help to determine the future profitability
of a firm. In the following section we will discuss these ratios for UPS. Taking
UPS ratios versus their competitors and the industry average we should be able
to give you a rough estimate of UPS future profitability conditions.
Gross Profit Margin
UPS FDX DHL Industry Avg
2001 13% 6% 7% 9% 2002 13% 6% 6% 8% 2003 13% 6% 7% 9% 2004 14% 6% 7% 9% 2005 14% 8% 8% 10%
UPS Financial Valuation James Ward, Mark Childers, Larry Abney, Josh Wayman
UPS 40
The gross profit margin formula involves gross profit divided by sales. Gross
profit margin basically shows how much sales is left over after taking cost of
goods sold out.
Gross Profit Margin
0%
2%
4%
6%
8%
10%
12%
14%
16%
2001 2002 2003 2004 2005
Years
Out
put
UPSFDXDHLIndustry Avg
To proficiently analyze a company, it is vital to look at this ratio. If the company’s
gross profit margin is higher than the industry average, the company is efficient.
In this case, UPS has a very high profit margin. This could be the result of very
high sales or a very low amount of cost of goods sold.
Operating Expense Ratio
UPS FDX DHL Industry Avg
2001 87% 95% 97% 93% 2002 87% 94% 100% 94% 2003 87% 94% 96% 92% 2004 86% 96% 96% 93% 2005 85% 77% 100% 87%
UPS Financial Valuation James Ward, Mark Childers, Larry Abney, Josh Wayman
UPS 41
The operating expense margin formula involves operating expenses divided by
sales. Operating expenses include wages, salaries, insurance, etc. It is very
important for this number to be small because an individual or owner should be
working toward increasing sales and decreasing the operating expenses, which is
ultimately taken out of net income.
Operating Expense Margin
0%
20%
40%
60%
80%
100%
120%
2001 2002 2003 2004 2005
Years
Out
put
UPSFDXDHLIndustry Avg
The percentage you arrive at is basically the percentage of each dollar that goes
to the operating expense. For example: Since UPS has on average about an 86%
margin, 86% of each dollar in sales goes to the operating expenses. From an
overall outlook, UPS is doing relatively well in comparison to the industry
average.
Net Profit Margin
UPS FDX DHL Industry Avg
2001 8% 3% 5% 5% 2002 10% 3% 2% 5% 2003 9% 4% 3% 5% 2004 9% 3% 4% 5% 2005 9% 5% 5% 6%
UPS Financial Valuation James Ward, Mark Childers, Larry Abney, Josh Wayman
UPS 42
The net profit margin formula involves net income divided by sales. In this case,
a high percentage is desirable. For every dollar UPS makes, about nine cents go
to net income.
Net Profit Margin
0%
2%
4%
6%
8%
10%
12%
2001 2002 2003 2004 2005
Years
Out
put
UPSFDXDHLIndustry Avg
When comparing companies in an industry such this, net profit margin is a very
good indicator of how one company can convert revenue into income versus
another. Net profit margin is also very beneficial when attempting to view how a
company controls its costs. UPS does an excellent job at this when comparing
them to the industry.
Asset Turnover
UPS FDX DHL Industry Avg
2001 1.23 1.36 0.21 0.93 2002 1.19 1.49 0.24 0.97 2003 1.16 1.46 0.26 0.96 2004 1.11 1.29 0.28 0.89 2005 1.21 1.44 0.26 0.97
UPS Financial Valuation James Ward, Mark Childers, Larry Abney, Josh Wayman
UPS 43
The asset turnover formula involves sales divided by total assets. This measures
how well your assets are used when generating sales. UPS has a lower asset
turnover than FedEx due mainly in part of the higher profit margin they contain.
Asset Turnover
0
0.2
0.4
0.6
0.8
1
1.2
1.4
1.6
2001 2002 2003 2004 2005
Years
Out
put
UPSFDXDHLIndustry Avg
Asset turnover is a very good indicator of seeing if one company is growing or
not. Through the five years, it is evident that both FedEx and DHL are growing
(asset use is growing and generating sales), while UPS is relatively stable. The
above numbers calculated from the ratios tend to be low. This is mainly due to
the sole fact that the above three are service companies. Inventory is low,
therefore the amount of assets they contain are low. Since DHL is a very small
company, it is easy to see why their turnover is minute.
Return on Assets
UPS FDX DHL Industry Avg
2001 11% 5% 1% 6% 2002 13% 5% 1% 6% 2003 11% 5% 1% 6% 2004 12% 5% 1% 6% 2005 12% 8% 2% 7%
UPS Financial Valuation James Ward, Mark Childers, Larry Abney, Josh Wayman
UPS 44
The return on assets (ROA) formula involves net income divided by total assets.
This basically tells you how well a company did from the asset use. There is no
question as to whether this number should be high or not. The ROA should be
high when comparing companies to see which are doing well in relation to asset
use. Over the years, UPS has dominated in this sector.
Return on Assets
0%
2%
4%
6%
8%
10%
12%
14%
2001 2002 2003 2004 2005
Years
Out
put
UPSFDXDHLIndustry Avg
While they did have a lower turnover than FedEx, they still managed to gain a
substantial difference with their returns. Basically, they made more money even
though the asset use of generating sales was not as great as FedEx. ROA is very
beneficial to investors because it tells them how well the company performs,
given what it has at stake.
Return on Equity
UPS FDX DHL Industry Avg
2001 25% 12% 40% 26% 2002 31% 12% 12% 18% 2003 23% 12% 26% 20% 2004 22% 12% 26% 20% 2005 24% 18% 28% 23%
UPS Financial Valuation James Ward, Mark Childers, Larry Abney, Josh Wayman
UPS 45
The return on equity formula involves net income divided by owner’s equity. This
ratio will basically inform you on how profitable a company is in relation to
shareholder input. It tells you how much a company can provide on return for
every dollar of equity.
Return on Equity
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
2001 2002 2003 2004 2005
Years
Out
put
UPSFDXDHLIndustry Avg
UPS and DHL are very close to the industry average while FedEx has historically
struggle in this particular area. From a long-term investing standpoint, the wise
choice would be to get in with UPS and DHL.
2001 2002 2003 2004 2005 Average
IGR 7.12% 9.57% 7.37% 7.65% 7.69% 7.88%
SGR 9.63% 12.09% 9.80% 10.42% 10.45% 10.48%
The above table shows both the Internal Growth Rate and the Sustainable
Growth Rate for UPS. Internal growth rate is a tool used to help determine how
effective the firm is at using their assets for growth. The IGR for UPS is very
steady over the previous 5 years, except for a spike in 2002. This is due to
retention of a large amount of cash that year, this was a result of September 11th
when due to the attacks firms where more reluctant to let go of cash incase of
another major catastrophe where they would need to be more liquid. Due to this
UPS Financial Valuation James Ward, Mark Childers, Larry Abney, Josh Wayman
UPS 46
we can reasonably predict a 7.5% annual growth coming from UPS. SGR, which
is a measure of how much a firm has the ability to grow, before needing
assistance by borrowing more funds to support their growth (Investopedia.com).
For the reason that the IGR is on average lower than the SGR we use that as a
conservative measuring tool for growth. We feel this will lead to a more
conservative forecasting and possibly undershoot some of their financials.
Profitability Analysis
2001 2002 2003 2004 2005 Opinion Gross Profit Margin
13% 13% 13% 14% 14% Neutral
Operating Expense Margin
87% 87% 87% 86% 85%
Neutral
Net Profit Margin
8% 10% 9% 9% 9% Positive
Asset Turnover
1.23 1.19 1.16 1.11 1.21 Positive
Return on Assets
11% 13% 11% 12% 13% Very Positive
Return on Equity
25% 31% 23% 22% 24% Positive
Overall the future looks bright for UPS profitability they have a very high
ROE and ROA, which will lead to much further growth for the firm. In conclusion
the analysis of the profitability of UPS is an overall rating of good.
UPS Financial Valuation James Ward, Mark Childers, Larry Abney, Josh Wayman
UPS 47
CAPITAL STRUCTURE RATIOS: The capital structure analysis consist of three ratios relating to where their
money for the firm is being raised. The three ratios that appear in the next
section are Debt-to-Equity, Times Interest Earned, and Debt Service Margin. We
will be further discussing these over the next few pages.
Debt-to-Equity Ratio
UPS FDX DHL Industry Avg
2001 1.4 1.27 26.16 9.61 2002 1.12 1.11 28.41 10.21 2003 0.95 0.88 22.29 8.04 2004 1.02 1.03 16.3 6.12 2005 1.09 0.53 14.6 5.41
The debt to equity ratio formula involves total liabilities divided by total owner’s
equity. This ratio informs individuals on the proportion of debt and equity is used
to finance its growth. It is also an overall measure of a company’s leverage.
Debt-to-Equity Ratio
0
5
10
15
20
25
30
2001 2002 2003 2004 2005
Years
Out
put
UPSFDXDHLIndustry Avg
UPS Financial Valuation James Ward, Mark Childers, Larry Abney, Josh Wayman
UPS 48
A high debt to equity ratio, such as DHL, basically means they are using an
excessive amount of debt in order to grow. This would have a negative impact in
the long run to investors and individuals of the company if not reduced
effectively. DHL had done this from 2001-2003, therefore taken on a significant
amount of risk, and now have reduced the debt. FedEx has a very low debt-to-
equity ratio in 2005, which intuitively can limit growth. Historically, the debt-to-
equity ratio should be around .5-1, which UPS and FedEx have. Therefore, one
can say UPS and FedEx have financial leverage.
Times Interest Earned
UPS FDX DHL Industry Avg
2001 22.39 8.06 12.16 14.20 2002 29.95 10.79 3.45 14.73 2003 37.12 9.7 3.22 16.68 2004 34.03 14.46 2.86 17.12 2005 36.32 20.42 4.66 20.47
The times interest earned formula involves operating income divided by interest
expense. This formula is an indicator of the amount of earnings available to meet
certain payments of interest.
Times Interest Earned
0
5
10
15
20
25
30
35
40
2001 2002 2003 2004 2005
Years
Out
put
UPSFDXDHLIndustry Avg
UPS Financial Valuation James Ward, Mark Childers, Larry Abney, Josh Wayman
UPS 49
Since UPS’s ratio is high and well above average, they are able to make the
interest payments. Since DHL’s ratios are very low, they will probably see
interest rate increases in the near future. A concern for companies such as DHL
is not only an increase in interest expenses, but also a potential threat into
bankruptcy.
Debt Service Margin
UPS FDX DHL Industry Avg
2001 7.53 8.08 7.81 2002 5.14 10.08 7.61 2003 6.79 7.4 7.10 2004 4.49 9.81 7.15 2005 7.06 8.45 7.76
The debt service margin formula involves the cash flows from year one divided
by last year’s current notes payable. It is basically an indicator of how much cash
is readily available for the repayment of interest for the next year.
Debt Service Margin
0
2
4
6
8
10
12
2001 2002 2003 2004 2005
Years
Out
put
UPSFDXDHLIndustry Avg
UPS Financial Valuation James Ward, Mark Childers, Larry Abney, Josh Wayman
UPS 50
UPS and FedEx have very similar margins. Since there are no major differences
or fluctuations, it is safe to say these companies will continue to have the
necessary amount to repay for upcoming years.
Capital Structure Analysis
2001 2002 2003 2004 2005 Opinion
DebEquity Ratio
t-to- 1.4 1.12 0.95 1.02 1.09
Positive
Times Interest Ratio
22.39 29.95 37.12 34.03 36.32 Negative
Debt Service Margin
7.53 5.14 6.79 4.49 7.06
Neutral
UPS’ debt to equity ratio is efficient in comparison to the industry average, and
much better than DHL. UPS and FedEx are historically doing well since the
average for the common debt to equity is .5 – 1. They are both financially
leveraged. UPS has a dominant hold in times interest earned, industry wide.
They have a significant amount of earnings available to meet their interest
payments. Therefore, no threat of bankruptcy is foreseeable. As far as the debt
service margins go, UPS and FedEx are basically the same, meaning they will be
able to meet future interest payments.
UPS Financial Valuation James Ward, Mark Childers, Larry Abney, Josh Wayman
UPS 51
Financial Statement Forecasting
Income Statement
To forecast sales for the income statement we calculated the IGR, which
came out to 7.88%. Since we feel that this number is sustainable we decided to
use that for all ten years of our forecasting. We took into account that there is
still more areas of the world that UPS could expand to and that the shipping
industry is showing no signs of slowing growth. For compensation and benefits
we took an average of the increase and determined that it increased about
6.88%. We used the same method when forecasting the operating expenses. We
did not forecast the other income section of the income statement since it was
too volatile. For determining the amount of income tax expense we took an
average of the income tax over operating expenses. Even though we forecasted
it out as 36% of operating expenses we realize that politics play into the income
tax rate and this could cause this to change at any point within the forecasting
period. To calculate net income for the forecasting period we used the average
net profit margin on 9% since it was extremely steady over the previous five
years.
UPS Financial Valuation James Ward, Mark Childers, Larry Abney, Josh Wayman
UPS 52
Balance Sheet
When we forecasted the balance sheet we looked for relationships among
the many line items of the balance sheet and used averages based on these
relationships. We also used some of the ratios from the ratio analysis for other
parts of the balance sheet. For the short-term assets other than the receivables
we just simply averaged the percent of each line item over total assets. Since
these common sized numbers were pretty stable we felt that this is a fairly
accurate method. For the accounts receivable we used the receivables turnover
ratio of 7.68 which we feel is not going to change very much during the
forecasting period. We calculated the forecast of total assets by using the IGR
from the past 5 years. We adjusted the IGR down from 7.88 to 7.5 for the asset
forecasting due to 2002 since UPS kept more cash on hand that year. Given how
2002 followed the September 11th attacks, which impacted the shipping industry
we felt that this was an anomaly and would most likely not happen again. We did
not forecast out the goodwill or intangible assets because they are based upon
acquisitions of other companies and it would be impossible to know when UPS is
planning to buy other companies. When we forecasted current liabilities we used
the current ratio of 1.71 and then we adjusted the components of current
liabilities based on historical ratios. The total liabilities were calculated as a
percentage of the average of current liabilities. We determined that current
liabilities were 37.3% of the total liabilities. We then calculated equity by
subtracting liabilities from total assets. We felt that this was the best way to
forecast equity since we had strong trends in our asset and liability forecasts and
because assets always equal liabilities plus equity.
UPS Financial Valuation James Ward, Mark Childers, Larry Abney, Josh Wayman
UPS 53
Statement of Cash Flows
When we forecasted the cash flow statement we first used the debt
service margin to obtain the operating cash flows. The average debt service
margin that we used was 6.022%. We felt this was the best way to predict the
future operating cash flows since it is based off of the balance sheet and
therefore involves two statements. After we determined the operating cash flows
we forecasted the line items by using their historical averages over the total
operating cash flows. We used this method since it was fairly stable and since
there were no other ratios that we could use. We decided not to forecast out the
investing or financing cash flows because of their historical volatility. These cash
flows both had wide ranges of totals through the five previous years.
UPS Financial Valuation James Ward, Mark Childers, Larry Abney, Josh Wayman
UPS 54
Analysis of Forecasted Statements
We feel that the growth that we forecasted for UPS is very attainable and
should be fairly accurate over the next 10 years. We have based this off of the
fact that UPS still has more geographic areas that they can expand into and
based upon the fact that over the past several months UPS has been innovative
in introducing new services that should help them expand in their current
markets. The biggest weakness in our forecast is based off of external factors.
We have no way in knowing if there will be an oil crisis which could dramatically
impact the operating expenses or another terrorist disaster that will shut down
transportation. We feel confident that the shipping industry is still going to
relevant even though the internet has increased in popularity. Our reasoning is
that e-mail cannot replace shipping and it would have a bigger impact on USPS
and other state owned mail services.
Cost of equity:
Historically, to find the cost of equity for a company, the Capital Asset
Pricing Model is used. However, after running all the regressions, we didn’t have
any R squares with explanatory power (see table below). As you can see for
every regression model we ran all of are adjusted R squares turned out to be
negative and because of this we could not use this method to come up with a
Ke. Therefore, we had to use a different model to determine the cost of equity.
We first tried a version of the discount dividends model but we were not
confident on the cost of equity that it gave us. We then decided to use long run
residual income perpetuity since it has greater explanatory power. The long run
perpetuity has more explanatory power compared to the discount dividends
model because it is not based on a dividend amount rather it based on long run
historical numbers. The equation we used is below.
UPS Financial Valuation James Ward, Mark Childers, Larry Abney, Josh Wayman
UPS 55
PPS = BPS (ROE −Ke )(Ke − g)
After using the above equation we will use a 13.09% cost of equity. This cost of
equity has a high explanatory power and is in line with the average cost of equity
in the market. However we still feel that we could have achieved a more
accurate cost of equity if we had a beta with explanatory power. In the above
equation we took an average of ROE from the past five years and used 25% as
our ROE. We also used a weighted average and got a 10% growth rate. The
book value per share and price per share were both taken from current data.
3 month Treasury Regression
Beta R^2 Ke 72 5.252 0 60 3.623 0 48 4.445 0 36 2.847 0 24 1.749 0
6 month Treasury Regression Beta R^2 Ke
72 0.024 0 60 -0.060 0 48 0.058 0 36 -0.126 0 24 -0.267 0
5 year Treasury Regression Beta R^2 Ke
72 1.849 0 60 1.871 0 48 2.067 0 36 1.787 0 24 1.727 0
7 year Treasury Regression Beta R^2 Ke
72 1.31 0 60 0.301 0 48 8.665 0 36 0.004 0 24 -5.617 0
20 year Treasury Regression Beta R^2 Ke
72 0.019 0
UPS Financial Valuation James Ward, Mark Childers, Larry Abney, Josh Wayman
UPS 56
60 -0.066 0 48 0.043 0 36 -0.135 0
24 -0.264 0 Cost of debt:
To calculate the cost of debt, we took each current liability and long-term
debt to weigh them appropriately. We were then to multiply these figures by
interest rates either given from the 10-K or on interest rate estimate based on
the industry, if not provided in the 10-K. After calculating the necessary figures
(see below table), we came up with a cost of debt approximating 5.69%. This is
a low cost of debt, which UPS is able to borrow at a low cost. Having a low cost
of debt is an advantage in their industry because they must purchase large fixed
assets and it is optimal to pay less than your competitors.
Current Liabilities Source Interest Weight Amount Current maturities of long-term debt and commercial paper 10-K 5.72% 9.98% 0.00571 983
Accounts Payable Estimate 6.25% 18.69% 0.01168 1841Accrued Wages & Withholdings Estimate 6.25% 13.23% 0.00827 1303Dividends Payable Estimate 0.00% 4.06% 0.00000 400Self Insurance Reserves Estimate 6.25% 6.92% 0.00433 682Income Taxes Payable Estimate 5.72% 1.03% 0.00059 101Other Current Liabilities Estimate 5.72% 14.30% 0.00818 1409Total Current Liabilities 6719Long Term Debt 10-K 5.72% 31.80% 0.01819 3133Total Liabilities 1 5.694% 9852
Weighted Average Cost of Capital:
UPS Financial Valuation James Ward, Mark Childers, Larry Abney, Josh Wayman
UPS 57
WACC =
After getting the end result of the cost of debt and equity, we can enter
these figures to arrive at the weighted average cost of capital, which is basically
the rate of return the company provides, given both debt and equity. This in turn
provides vital information for existing and potential investors. WACC is also an
indicator on value. If the market return is higher than WACC then the company is
creating value, in turn if the return is lower than WACC they are destroying
value. To find the weighted average cost of capital (WACC), we used the
following formula:
V V(Ke )× (Kd )(1−T)e
Vf
d
Vf
WACC = 7.7% =7500
17352(.1309) × 9852
17352(.0569)(1− .35)
Vd Ve Vf Tax Rate Ke Kd
9852 7500 17352 0.35 0.1309 0.0569 35.00% 13.09% 5.69%WACC 7.7%
UPS Financial Valuation James Ward, Mark Childers, Larry Abney, Josh Wayman
UPS 58
Valuation Models
Comparables Valuations
With the method of comparables we derive a share price for UPS using
earnings multiples from competitors as well as the industry average. The method
of comparables does not give us an accurate valuation because it uses an
industry average. Although the method of comparables does not necessarily give
us an accurate price per share it is still useful for comparison purposes because it
is quick and relatively easy to perform. For our valuation we used information
from 2001-2005, because not all firms in the comparison had reported figures for
2006. When calculating the industry average UPS was omitted. We were unable
to use the PEG ratio in this valuation due to a negative industry average for this
ratio.
Method of Comparables
PPS EPS BPS DPS
UPS 74.68 3.48 31.65 1.32
FDX 95.65 5.94 67.79 0.29
DHL 17.3 1.99 15.4 0.70
Trailing Price/Earnings:
UPS 21.46 Industry 18.88 FDX 16.10 UPS EPS 3.48 DHL 8.69
Est. Share Price
$65.70
The Trailing P/E estimates the share price to be $65.70. This means that
UPS is overvalued at a current share price of $76.68. We derived this result by
dividing the price per share for that period by the earnings per share from the
last period. Finally we multiplied the industry average by the earnings per share
(EPS) for UPS to arrive at the estimated share price.
UPS Financial Valuation James Ward, Mark Childers, Larry Abney, Josh Wayman
UPS 59
Forward Price/Earnings:
UPS 19.91 Industry 17.05 FDX 13.08 UPS EPS 3.75 DHL 8.69
Est. Share Price
$63.94
The forward P/E estimates the share price to be $63.94. This means that
UPS is overvalued at a current share price of $76.68. We derived this result by
dividing the price per share for that period by the projected earnings per share
for the next period. Finally we multiplied the industry average by the earnings
per share (EPS) for UPS to arrive at the estimated share price.
Market/Book:
UPS 2.36 Industry 1.63 FDX 1.41 UPS BPS 31.65 DHL 1.12
Est. Share Price
$51.59
The Market/Book ratio estimates the share price to be $51.59. This means
that UPS is overvalued at a current share price of $76.68. We derived this result
by dividing the price per share by the book value of equity per share. Finally we
multiplied the book value of equity per share by the industry average to arrive at
the estimated share price.
Dividend/Price:
UPS .018 Industry .016 FDX .003 UPS DPS 1.32 DHL .040
Est. Share Price
$82.50
UPS Financial Valuation James Ward, Mark Childers, Larry Abney, Josh Wayman
UPS 60
The Dividend/Price ratio estimates the share price to be $82.50. This
means that UPS is undervalued at a current share price of $76.68. We derive this
result we divided dividends per share by price per share to find the industry
average. Finally we divided dividends per share for UPS by the industry average
in order to arrive at the estimated share price.
Discounted Dividends
Discounted dividends valuation uses the cost of equity as the discount
rate to find the present value of future dividends paid by UPS. The formula for
discounting dividends is listed below.
( )PPSt =
⎛⎝⎜
⎞⎠⎟
+
+
=
∞
∑E d
k
t
e
tt
~
1
1 1
Along with discounted the dividends, the equation for a future perpetuity is
stated below.
PPSt =
⎛⎝⎜
⎞⎠⎟
−
+E d
r g
t
~
1
We forecasted our dividends until the year 2016 with a perpetuity starting in
2017. Below is our actual value and the sensitivity analysis for this valuation
method.
UPS Financial Valuation James Ward, Mark Childers, Larry Abney, Josh Wayman
UPS 61
Present Value of Future Dividends Total Present Value of Forecast Future Dividends $14.62 Continuing (Terminal) Value (assume no growth) $5.40 Present Value of Continuing (Terminal) Value $51.07 Estimated Value per Share at 12/31/2006 $65.69 Implied 4/01/2007 value $67.75 Earnings Per Share Dividends per share Book Value Per Share $14.46 Actual Price per share $70.10 Cost of Equity 13.09% Growth Rate 10.0%
With our cost of equity at 13.09% and a growth rate on dividends at 10%
we find the value of UPS to be $65.69 per share. Using close cost of equity
measurements, we found that price fluctuated fairly well. We were able to use a
growth rate of 10% because UPS has steadily increased over the previous 5
years and we feel they will continue to do this. With this valuing method it shows
UPS being over-valued by $4.41.
Sensitivity Analysis g 2.5% 5.0% 7.5% 10.0% 10.5% 11.0%
Ke 10% $44.64 $58.52 $100.15 NA NA NA 11% $38.47 $47.79 $70.43 $206.27 $396.45 NA 12% $33.67 $40.20 $54.00 $102.30 $131.27 $189.23 13.1% $29.52 $34.13 $42.85 $65.69 $75.55 $90.13 14% $26.71 $30.22 $36.45 $50.45 $55.66 $62.59 15% $24.12 $26.79 $31.24 $40.13 $43.10 $46.81
UPS Financial Valuation James Ward, Mark Childers, Larry Abney, Josh Wayman
UPS 62
Free Cash Flows
The Free Cash Flows Valuation Model is obtained from the dividend
discount model. Since we have already found the Cash Flow from Operations
(CFFO), the Cash Flow from Investing (CFFI), and the WACC, and forecasted
these out for 10 years. This allows us to find the value of the free cash flows
discounted back to December 31st of 2006. Free cash flows are found by taking
that years CFFO and subtracting out the CFFI from that year and that we will
give you the free cash flow. This number is then divided by (1+WACC)t, where t
is the year that we are forecasting. This gives us the present value of the annual
free cash flows, we then find the present value of the of the perpetuity and add
it to the sum of the annual cash flows. Then subtracting debt and dividing by the
number of outstanding shares will give us the value of UPS on a per share basis.
FCF = CFFO – CFFI FCF = Free Cash Flows CFFO = Cash Flows from Operations CFFI = Cash Flows from Investing
Present Value of Free Cash Flows Total Present Value of Annual Cash Flows $39,642Continuing (Terminal) Value (assume no growth) $128,157Present Value of Continuing (Terminal) Value $60,979Value of the Firm (end of 2006) $100,621Book Value of Debt and Preferred Stock $18,388Value of Equity (end of 2006) $82,233Estimated Value per Share at 12/31/07 $76.85Implied Share Price at 04/01/07 $78.29 Actual Price per share $70.10 WACC 7.71%Growth Rate 0.00%Number of Shares Outstanding @ 12/31/06(in mil) 1070
UPS Financial Valuation James Ward, Mark Childers, Larry Abney, Josh Wayman
UPS 63
Due to the fact that UPS has a long history and able to sustain itself in a
competitive market we used a growth rate of 0, but thanks to a sensitivity
analysis we can compare the price with several different WACC and several
growth rates. With our WACC of 7.71% and the growth of 0 the value of UPS
comes to $76.85 per share. Which would under-value UPS by $6.75.
Sensitivity Analysis
g 1.00% 0.00% -2.50% -3.00% -5.00% -10.00%WACC 5.00% $166.01 $137.66 $99.87 $95.14 $80.97 $62.07
6.00% $125.69 $108.50 $83.22 $79.85 $69.44 $54.79 7.71% $85.35 $76.85 $62.90 $60.89 $54.43 $44.67 8.00% $80.54 $72.90 $60.17 $58.32 $52.34 $43.20 9.00% $66.77 $61.35 $51.93 $50.51 $45.87 $38.54
Residual Income Valuation The residual income valuation model uses equity to value a company. First
you start out with the beginning book value of equity and add in earnings less
dividends. This results in the ending book value of equity. Next normal income is
calculated. Normal income is composed of the cost of equity multiplied by last
year’s book value of equity. This gives you a benchmark of how your company
should perform to keep up with cost of equity. Residual income is the difference
between your earnings and your normal income is the amount by which you beat
or missed your cost of equity. The firm is valued by taking the book value of
equity plus the sum of the present values of the residual income plus the present
value of the perpetuity divided by the number of shares outstanding. Looking at
the residual income valuation you see that they have consistently and with an
increasing amount beat their cost of equity therefore a negative growth rate is
needed when creating a sensitivity analysis. Even with using a negative growth
rate the valuation numbers are substantially different than the other models.
According to these numbers UPS is extremely overvalued. Potential reasons that
UPS Financial Valuation James Ward, Mark Childers, Larry Abney, Josh Wayman
UPS 64
the residual income valuation gives an extremely low valuation are the cost of
equity and the forecasted equity. Since cost of equity could not be found using
the CAPM method we are not as confident on the value. Changes in the cost of
equity can change the values given out by the residual income method. The
other potential reason and the more likely reason is that equity for UPS is hard to
predict. Since the RI model uses equity in its valuation it is important to have an
accurate book value of equity. Items such as additional paid-in capital and other
comprehensive losses along with retained earnings can vastly change the book
value of equity. After looking into all the models we have concluded that the
Residual Income model is not an effective way to value UPS. We are placing less
weight on this model when determining a value for the company.
Sensitivity Analysis g Ke -5% -10% -20% -30% -40% -50%
8% $36.68 $34.63 $32.72 $31.82 $31.29 $30.9510% $35.69 $34.09 $32.49 $31.69 $31.21 $30.8912% $34.94 $33.66 $32.29 $31.58 $31.14 $30.84
13.09% $34.60 $33.45 $32.19 $31.52 $31.10 $30.7915% $34.09 $33.13 $32.03 $31.42 $31.04 $30.77
BV Equity 2006 $17,728.00Total PV of RI (end 2006) $13,904.28Continuation (Terminal) Value $8,241.67PV of Terminal Value (end 2006) $2,407.76Estimated Value as of 13/31/06 $31.52Implied Value as of 04/01/07 $32.50 Actual Price per share $70.10 Growth -30.00%Ke 13.09%
UPS Financial Valuation James Ward, Mark Childers, Larry Abney, Josh Wayman
UPS 65
Abnormal Earnings Growth Model
To calculate abnormal earnings, we started with the previous year’s
dividends (DPS) and multiplied it by our cost of equity, 13.09%, to end up with
our DPS. Next, we used our calculated DPS and added earnings per share to end
up with cum-dividend earnings. To calculate normal earnings, we simply took the
previous year’s earnings per share multiplied by one plus the cost of equity,
stated above. Then, to arrive the AEG, we took cum-dividend earnings and
subtracted normal earnings. After this, we multiplied the AEG times the present
value factor, which is 1/(1+ke)^t. This gave us the present value of abnormal
earnings growth. Adding up each year’s present value of AEG gave us the total
PV of AEG.
By going through sensitivity analysis, we were able to end up at the closest price
in respect to our cost of equity, 13.09% and using the growth rate of -1%.
Sensitivity Analysis g -1% -2% -3% -4% -5% -6%
10% $99.84 $90.61 $82.92 $76.43 $70.88 $66.0711% $87.43 $80.10 $73.89 $68.57 $63.96 $59.9312% $77.55 $71.60 $66.49 $62.06 $58.18 $54.76
K 13.09% $68.88 $64.04 $59.84 $56.15 $52.89 $49.9914% $62.91 $58.79 $55.17 $51.97 $49.12 $46.5615% $57.38 $53.87 $45.51 $47.79 $45.51 $43.2716% $52.69 $49.67 $46.97 $44.56 $42.38 $40.40
In actual analysis, it is safe to say that if UPS’ price will fluctuate in
regards to cost of equity. For UPS, a lower cost of equity brings their value up,
going away from actual price. With a higher cost of equity, UPS’ value goes up
with a shorter growth rate. In respect of maintaining or destroying value, UPS
never destroyed value. Cumulative dividend earnings were maintained at a
higher number than normal earnings, which is vital.
UPS Financial Valuation James Ward, Mark Childers, Larry Abney, Josh Wayman
UPS 66
Altman Z-Score
The Altman z-score was created in the 1960s as a way to predict bankruptcy in
companies (Investopedia.com). Today the score is widely used by financial
institutions as a way to determine the credit of a company. The score is a
weighted sum of different ratios. The ratio with the largest weight is the EBIT
over total assets. This one is weighted the highest because it shows how much
the company brings in based on the assets that it has. If this ratio were to get
low then it means the company is not using their assets efficiently and
bankruptcy could soon follow. A good score is above 3 while below 1.8 is bad, in
between these two values is a gray area that depends on the person using the
score. (Investopedia.com) The formula for the z-score is below:
z − score =1.2(Working CapitalTotal Assets
) +1.4(Retained EarningsTotal Assets
) + 3.3( EBITTotal Assets
) + .6(MVe
BVl
) +1( SalesTotal Assets
)
We calculated five years worth of data to get the average historical z-score for
UPS. We also calculated each years z-score. Below is the equation of the average
historical z-score:
z − score =1.2(16,35831,357
) +1.4(15,14631,357
) + 3.3( 5,40231,357
) + .6(67,67416,147
) +1(38,29331,357
)
After calculating the above equation we have an average historical z-score of
5.61 and the range of scores from 5.21-6.02. This information leads us to believe
that UPS is a very stable company. Theses scores are well above the minimum
for being good and there is no apparent risk of bankruptcy anytime soon. This
also means that when UPS borrows debt they can get it relatively inexpensive.
UPS Financial Valuation James Ward, Mark Childers, Larry Abney, Josh Wayman
UPS 67
Valuation Conclusion
After running all of the valuation models, and analyzing these models and
the overall state of the firm we can effectively come to the conclusion that UPS is
a fairly valued company and would recommend that an investor hold if already
own. We would not advise anyone to purchase share of this firm unless that
investor is strictly holding for dividends as UPS has been very consistent in there
offering of them. Our residual income model was the only model that gave us a
valuing far different than the other models. We decided to not place any weight
on this valuation method. The other three intrinsic methods were the AEG, Free
Cash Flows, and Discounted Dividends and when averaging these three methods
we came up with an average share price of $70.47. This is extremely close to the
April 1st, 2007 price of $70.10, for this reason is why we came to our fairly
valued conclusion.
UPS Financial Valuation James Ward, Mark Childers, Larry Abney, Josh Wayman
UPS 68
Appendix
Diagnostic Ratios Ratio Analysis WACC Cost of Equity Method of Comparables Discounted Dividends Free Cash Flows Residual Income Abnormal Earnings Growth Altman Z-Score