The management teams of package delivery company UPS (NYSE:UPS) and multi-industry industrial 3M (NYSE:MMM) are in a hurry. Both are enacting significant changes to their businesses with the aim of improving performance. As such, their stocks represent excellent buying opportunities for value-oriented investors. Here’s why.
Surging e-commerce volumes, particularly in business to consumer (B2C) deliveries to residential deliveries bring about opportunities, but also challenges, for UPS. In common with FedEx (NYSE:FDX), UPS has enjoyed strong e-commerce-related volume growth in recent years. That’s undoubtedly a positive, but it also has some negatives as well:
- UPS and FedEx have seen margin challenges due to surging B2C deliveries as, among other issues, inefficiently packaged and bulky deliveries are costly to deliver to residential addresses.
- Both companies have been forced to increase capital expenditures to expand/upgrade their delivery networks in order to service e-commerce growth.
What investors want to see from UPS
As such, the earnings calls of FedEx and UPS have been peppered by questions from analysts enquiring on margin progression and capital spending requirements. The fear is that margins were permanently in decline and that both companies were stuck in an endless cycle of capital spending that would eat into free cash flow generation.
However, UPS’s new CEO Carol Tome has clearly signaled that she understands investors’ concerns and is totally focused on raising the margin profile of the company while sweating its existing assets. For example, during the second-quarter earnings call, Tome answered a question by saying: “PSR for UPS is the name of the game. We are all in. And as a leadership team, this is what we talk about as we get together on a weekly, hourly basis.”
By “PSR for UPS,” Tome is referring to the precision scheduled railroading initiatives that have significantly improved margins in the railroad industry. No need to get into the details of that — suffice it to note that PSR is a set of principles dedicated to generating more profits from using fewer assets by focusing on improving various key operating metrics, rather than chasing volume.
Conditions are favorable
Given the ongoing strength in volume growth, it looks like the conditions are ripe for Tome to achieve her aim of becoming “better, not bigger.” Indeed, actions are being taken to control and optimize volume and improve pricing. Moreover, Tome cited the decision of “not buying aircraft to have excess capacity. That would have been value-destroying, so we opted not to make that capital investment” as an example of the changes.
Tome told investors to expect margin expansion in the years to come and told analysts to pencil in $4 billion for capital expenditures in 2021 — a big drop from the $5.6 billion expected in 2020.
All told, end markets are favorable and Tome is doing what many investors want to see from UPS. Meanwhile, the stock trades on an attractive valuation and sports a 2.4% dividend yield.
The industrial giant has lost its way in recent years amid margin declines and a disappointing track record of missing guidance. As such, it no longer commands the valuation premium that it once did over its industrial peers.
But here’s the thing. Would you rather buy a stock trading at a valuation premium with a management team failing to address its failure to hit its own targets, or a stock trading at a valuation discount with a management team determined to turn performance around?
3M is definitely in the latter camp right now. CEO Mike Roman has been enacting significant restructuring actions on the company. They include reducing the number of reporting segments from five to four, eliminating layers of management, running individual businesses on a global level rather than under a regional umbrella, and streamlining the organization with job cuts.
There’s no guarantee that Roman will be successful in turning around margin performance, but the company continues to generate large cash flows (see chart above), which will give him the firepower to restructure the existing company and make acquisitions in order to fuel growth. Just as with UPS, 3M’s management is committed to improving performance, and it’s a favorable environment to do so. Furthermore, 3M’s valuation is attractive, and just as with UPS, that makes the stock a buy on a risk/reward basis.