The Latest Expansion At UPS

By Chad Langager | May 17, 2006 AAA

United Parcel Service (UPS), the world's largest package delivery company, recently announced a $1 billion plan to expand its main sorting complex in Louisville, Kentucky. The plan calls for a 1.1 million square foot addition to its UPS Worldport facility, which is the company's largest sorting facility and main hub to the international market. The expansion, expected to be completed by 2010, will expand the hub's sort capacity from 304,000 packages per hour to 487,000 packages per hour.

The expansion of the four-year old facility, which is the most technologically advanced sorting complex in the world, is being made to meet expected future demand for product shipping as global trade continues to show strength. UPS has seen this strength first-hand, as its average daily package volume increased 4.3% in 2005, from 14.1 million in 2004 to 14.75 million in 2005. The international segment saw the biggest jump, as average volume increased by 7% to 1.36 million packages daily.

Due to across-the-board increases in average revenue per package shipped, the growth in package volume which UPS saw in 2005 easily translated into strong growth in the company's financials. In 2005, UPS reported total revenue growth of 9.2% as consolidated revenue rose to $36.58 billion from $33.49 billion in 2004.

And again, the strongest growth segment was international packaging, which saw revenues rise 21.4% compared to 6.3% in the domestic packaging segment. The international packaging segment now comprises 18.6% of total revenue, up from 16.7% in 2004.

Positioned in over 200 countries with nearly 600 airplanes, UPS is well positioned to benefit from global economic and trade growth. The other macro-benefit that UPS is likely to gain from is the increased reduction in trade barriers in countries such as China, which only serves to increase its customer base. So with UPS showing continued strength in its operations along with a solid macro theme of global trade growth, does this make UPS a good investment?

Warren Buffett seems to think so, as Berkshire Hathaway (BRK.A) recently reported a $113 million stake in the company. UPS sports a wide economic moat as there are few competitors in the field, with the only other major players being FedEx (FDX), DHL (DPSTF) and TNT (TP). UPS and the industry also enjoy almost unlimited barriers to entry due to the extensive capital costs that one would incur building the network and infrastructure necessary to compete.

The major negative here, is that even with the economic moat, the company is still competing in a commodity business, where price is the major concern for consumers. This can easily lead to increased competition from firms already established in the industry reducing the company's margins.

But so far, UPS's margins have held steady over the last five years, with operating and profit margins averaging 13.5% and 8.9% respectively. We also see the strength of UPS's operations in its ability to generate strong cash flow from operations, which has averaged a little over $5 billion per year for the last five years.

Looking at the P/E ratio for UPS as a rough guide of valuation, the company is currently trading at the lower range of its historical valuation. UPS currently has a trailing P/E ratio of 22.31 based on 2005 earnings and over the last five years the company's P/E has ranged from 21.7 to 29.2.

So if you believe that economic growth and trade around the world will remain strong, UPS may be a great play on this macro theme. While more due diligence is needed to come up with a conclusion on an investment in UPS, with the likes of Warren Buffett jumping in, it just may be the right time to add UPS to your portfolio.

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