Executive Summary - Texas Tech Universitymmoore.ba.ttu.edu/ValuationReports/Spring2007/UPS-Spring2007.pdf · Shares Outstanding 1,080,000,000 Ratio Comparison UPS FDX DHL ... Industry

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 2

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


UPS 4

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.


UPS 5

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.


UPS 6

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


UPS 7

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.


UPS 8

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


UPS 9

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.


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.


UPS 11

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


UPS 12

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


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


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


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


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


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 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 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.


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 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 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 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 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 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 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 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 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 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 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 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 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 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 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 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


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 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



UPS 37

Days Outstanding

0

10

20

30

40

50

60

70

80

2001 2002 2003 2004 2005

Years

Out

put


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 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


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 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 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


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


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 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


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


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 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


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


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 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


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


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 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


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


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 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


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 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 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


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



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


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



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


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



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 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 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 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 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 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


72 1.31 0 60 0.301 0 48 8.665 0 36 0.004 0 24 -5.617 0


72 0.019 0


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 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 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 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 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 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 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 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 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 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 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 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 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

Documents

Executive Summary - Texas Tech Universitymmoore.ba.ttu.edu/ValuationReports/Spring2007/UPS-Spring2007.pdf · Shares Outstanding 1,080,000,000 Ratio Comparison UPS FDX DHL ... Industry