The shipping giant expects profit margins to expand over the coming three years, driving earnings growth of about 15% a year on average.
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United Parcel Service stock is still a buy, even after this past week’s disappointing investor event. The world is a very different place that it was a few years ago. That should help the company’s business—and its price/earnings multiple.
UPS (ticker: UPS) met with investors Wednesday. Expectations were high. Shares were up 25% for 2021 and up 90% over the past 12 months. UPS failed to live up to them, though. Investors wanted more aggressive cost cutting, earnings growth projections, and share-repurchase plans. Shares dropped 4.1% Wednesday and were down 3.5% for the week.
Investors are being a little too short-term-focused. Over the past three years, the shipping giant’s operating profit margins have fallen. That’s limited its earnings growth to roughly 5% a year on average. Parcel shipping was a tough business.
But coming out of Covid-19, pricing is strong, online shopping has exploded, and new business opportunities are popping up, such as temperature-controlled shipping for the healthcare industry. The company expects profit margins to expand over the coming three years, driving earnings growth of about 15% a year on average.
Higher growth should eventually be rewarded with higher stock valuations.
Over the past few years, UPS stock has traded at roughly 17 times estimated earrings, a 16% discount to the S&P 500 multiple of about 20 times. A lower multiple seemed appropriate, since UPS’s earnings weren’t growing as fast as the market.
Today, UPS stock is trading at about 18.5 times earnings. That’s a 17% discount to the current market multiple of about 22 times. The shipping business is better and earnings growth is expected to accelerate, but investors are paying less for UPS earnings, relative to the S&P 500, than in the recent past.
Something isn’t adding up. UPS stock deserves, at least, a marketlike P/E ratio. That would mean the stock, now at $203.20, could trade at roughly $290 in two years, based on management’s earnings projections. That implies an upside of about 43%.
When Barron’s picked UPS stock back in May 2019, we called it an undervalued buy. Shares have doubled since then. They don’t look as undervalued anymore. But the stock’s P/E ratio can still expand. Shares don’t reflect all the changes in shipping and supply chains necessitated by Covid-19.
At least one analyst seems to agree. J.P. Morgan’s Brian Ossenbeck upgraded UPS shares to Buy from Hold on Thursday, after UPS’s investor day. His raised his price target to $243 from $224—about 22 times his estimated 2021 earnings of $11 a share. That’s in line with the broader market.
With the investor event in the rearview mirror, Ossenbeck believes investors will start to focus on growth and pricing power. We agree.
Write to Al Root at [email protected]
