UPS CEO Carol Tome.
Photo by JIM WATSON/AFP via Getty Images
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United Parcel Service operated a bit like the New York Yankees until recently. But the company has changed in ways that are positive for the stock.
Investors and baseball fans may know that the Bronx Bombers have adopted an appearance policy unique among premier league clubs. Most facial hair is forbidden: Yankees are clipped tight.
Investors may not be aware that UPS (ticker: UPS) had a similar policy until recently. Until two years ago, UPS drivers, dressed in neatly pressed brown uniforms, wore no facial hair or tattoos.
It was just company policy. It started generations ago to help UPS gain a competitive advantage. Delivery drivers who could go through the front door instead of the loading dock can be faster and bond with entrepreneurs.
But 1907, the year UPS was founded, is more than a century ago, and times are changing. CEO Carol Tome eased policy when she took over at UPS in mid-2020, though limits still exist. Beards should be neatly maintained, and tattoos on faces or hands are prohibited.
“That was not allowed here; let people be themselves,” CFO Brian Newman told Barron’s. He believes the change has benefited his business. “In a time of the pandemic, with many challenges, people [felt] better to come and work for UPS,” he says.
Tome arrived at UPS in June 2020, early enough in the Covid-19 pandemic that no one knew how it would end. The result so far is so good.
Shares of UPS have returned an average of about 37% per year since Tome’s inception, while the S&P 500 has returned about 14%. The comparable figure for the Dow Jones Industrial Average is about 13%.
The story goes beyond beards and tattoos, of course. Newman says Tome has emphasized “better, not bigger,” which includes looking more closely at profitability by package and pursuing small and medium-sized customers.
The idea of focusing on profitable packages may seem obvious. But UPS is a complex network, and allocating costs correctly is difficult. With her background as CFO of Home Depot (HD), Newman and Tome worked to develop systems that could more accurately represent the types of businesses that yielded the highest profits.
Tome also sent resources to smaller clients, which are more profitable for her business. Small and medium enterprises now account for about 27% of UPS revenue, compared to 23% a year ago. Newman believes that 30% is possible.
All those changes appear in the financial statements. Operating profit margins have increased by about three percentage points since 2020, from 10.5% to about 13.5%. Newman believes the profit improvement game is still in the “early innings” and is working to improve margins by about 0.5 percentage points per year for the foreseeable future.
While Newman’s excitement about the future is palpable, analysts aren’t entirely convinced. Only about 47% of the stocks cover UPS stock at Buy, while the average Buy rating ratio for S&P 500 is about 58%.
An important reason for the below-average purchase ratio is the margins. Wall Street expects operating profit margins to fall by nearly half a percentage point between 2022 and 2024 — the opposite of what Newman expects.
However, if things go as Newman envisions, UPS’s operating profit could be approximately $15.8 billion by 2024. That’s about $1.5 billion more than Wall Street is currently forecasting.
That would roughly add another $1.60 in earnings per share in 2024, for the year’s earnings per share of about $15.41. To reach that level of the $12.77 in earnings per share expected this year, payments would need to grow at an annual average of about 10%. That’s about three percentage points ahead of forecast earnings growth for the S&P 500.
If UPS can pull that off, stocks at current levels could be a bargain. UPS shares are trading at about 13.8 times estimated 2023 earnings, while the S&P 500 is trading at about 15.7 times. If UPS stock trades at a valuation similar to the overall market, UPS stock could hit $240 in the next 12 months, a gain of about 30% from current levels.
Slower economic growth is the greatest risk in Newman’s view. It can make it difficult to expand profit margins and increase the stock price relative to expected earnings.
But UPS isn’t the only company hit by a slowing economy. And if a recession is on the horizon, investors still have Tome at the helm. Considering the first few years of her tenure, that should help them calm down.
