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Estimating The Fair Value Of United Parcel Service, Inc. (NYSE:UPS)

Key Insights

  • Using the 2 Stage Free Cash Flow to Equity, United Parcel Service fair value estimate is US$147

  • With US$172 share price, United Parcel Service appears to be trading close to its estimated fair value

  • Analyst price target for UPS is US$190, which is 29% above our fair value estimate

How far off is United Parcel Service, Inc. (NYSE:UPS) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the expected future cash flows and discounting them to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. There's really not all that much to it, even though it might appear quite complex.

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

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Check out our latest analysis for United Parcel Service

Crunching The Numbers

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. To begin with, we have to get estimates of the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) estimate

2023

2024

2025

2026

2027

2028

2029

2030

2031

2032

Levered FCF ($, Millions)

US$7.40b

US$8.60b

US$8.65b

US$9.41b

US$9.08b

US$8.93b

US$8.89b

US$8.91b

US$8.98b

US$9.09b

Growth Rate Estimate Source

Analyst x12

Analyst x12

Analyst x7

Analyst x2

Analyst x1

Est @ -1.66%

Est @ -0.53%

Est @ 0.26%

Est @ 0.82%

Est @ 1.21%

Present Value ($, Millions) Discounted @ 8.2%

US$6.8k

US$7.3k

US$6.8k

US$6.9k

US$6.1k

US$5.6k

US$5.1k

US$4.7k

US$4.4k

US$4.1k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$58b

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.1%. We discount the terminal cash flows to today's value at a cost of equity of 8.2%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$9.1b× (1 + 2.1%) ÷ (8.2%– 2.1%) = US$152b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$152b÷ ( 1 + 8.2%)10= US$69b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$127b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of US$172, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf
dcf

The Assumptions

We would point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own assumptions. The DCF also does not consider the possible cyclicality of an industry, or a company's future capital requirements, so it does not give a full picture of a company's potential performance. Given that we are looking at United Parcel Service as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighted average cost of capital, WACC) which accounts for debt. In this calculation we've used 8.2%, which is based on a levered beta of 1.031. Beta is a measure of a stock's volatility, compared to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

SWOT Analysis for United Parcel Service

Strength

  • Earnings growth over the past year exceeded the industry.

  • Debt is well covered by earnings and cashflows.

  • Dividends are covered by earnings and cash flows.

Weakness

  • Earnings growth over the past year is below its 5-year average.

  • Dividend is low compared to the top 25% of dividend payers in the Logistics market.

Opportunity

  • Annual earnings are forecast to grow for the next 3 years.

  • Good value based on P/E ratio compared to estimated Fair P/E ratio.

Threat

  • Annual earnings are forecast to grow slower than the American market.

Looking Ahead:

Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for a company. The DCF model is not a perfect stock valuation tool. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For United Parcel Service, there are three pertinent elements you should assess:

  1. Risks: Be aware that United Parcel Service is showing 1 warning sign in our investment analysis , you should know about...

  2. Future Earnings: How does UPS's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.

  3. Other High Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

PS. Simply Wall St updates its DCF calculation for every American stock every day, so if you want to find the intrinsic value of any other stock just search here.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

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