New Portfolio Addition - 06/10/2025
Pellom Value Investments LLC is a private family office registered in the state of Tennessee. Pellom Value Investments LLC is not a registered investment advisor with any governing or regulating body.
Pellom Value Investments LLC is a private family office registered in the state of Tennessee. Pellom Value Investments LLC is not a registered investment advisor with any governing or regulating body. Nothing in this website should be construed as a public offering or solicitation. We do not accept outside funds for our services. We are not professional investment advisors, nor do we represent ourselves as such.
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United Parcel Service (UPS) began its journey in 1907 when 19-year-old James E. Casey and Claude Ryan, with a borrowed $100, founded the American Messenger Company in a Seattle basement. Initially delivering messages and packages on foot or by bicycle, the company quickly earned a reputation for reliability. By 1913, they acquired their first delivery truck, a converted Ford Model T, and focused on retail store deliveries, rebranding as Merchants Parcel Delivery. The iconic brown uniform and vehicles were introduced in 1916. Expanding beyond Seattle to Oakland, California, in 1919, the company adopted its current name, United Parcel Service. UPS steadily grew, eventually moving its headquarters to New York City and by 1975, it became the first package delivery company to serve every address in the contiguous United States. Further expansion into air freight led to the creation of UPS Airlines in 1988, which rapidly became one of the largest airlines globally. Today, UPS operates in over 220 countries and territories, evolving into a multinational logistics giant through strategic acquisitions and continuous innovation.
You might have noticed that UPS stock hasn't had the best run lately. There are definite headwinds, like macroeconomic uncertainty and global trade tensions. But a big part of the UPS story, is a strategic shift under CEO Carol Tomé.
The core of this strategy is called "Better, Not Bigger". Think of it this way: instead of chasing every single package that moves through the network, regardless of how profitable it is, the focus is on improving the quality of the business and the returns generated. It's about prioritizing "economic profitability" and how effectively the company uses its capital to generate returns (ROIC). Value, in this view, is created when that return on invested capital (ROIC) is higher than the cost of capital.
This means management is making deliberate choices about where they want to grow. The strategy focuses on growing in parts of the market that particularly value UPS's comprehensive network. These include healthcare, business-to-business (B2B), small- and medium-sized businesses (SMBs), and international markets. These segments are seen as higher-yielding and offering better margin potential compared to some other types of volume.
ROIC has dropped significantly over the past three years as COVID related profits have washed out. However, as you’ll see below, UPS has historically performed far better in this category than its largest competitor, FedEx.
One of the most significant actions tied directly to this "Better, Not Bigger" strategy and the focus on higher-yielding volume is the decision regarding their largest customer, Amazon.com, Inc. and its affiliates. For the year ended December 31, 2024, Amazon represented approximately 11.8% of UPS's consolidated revenues, mostly within the U.S. Domestic Package segment.
In the first quarter of 2025, UPS entered into an agreement in principle with Amazon that will result in a significant reduction in the volume they deliver for them. They expect volume to decline to approximately 50% of year-end 2024 levels by mid-2026.
From a "Better, Not Bigger" perspective, this reduction in Amazon volume is viewed as a deliberate shift to increase the focus on growing higher-yielding volume. Although losing volume, particularly from a large customer, might seem counter-intuitive to growth, Amazon's business was relatively low-margin. By reducing reliance on this low-margin volume, UPS can allocate resources and capacity to more profitable opportunities in their targeted growth areas like healthcare and SMBs. Management has stated that this shift is intended to ultimately enhance profitability.
To support this strategic pivot and manage the impact of changing volume, UPS is undertaking significant initiatives to improve efficiency and reduce costs. This includes programs like "Fit to Serve," which resulted in a workforce reduction of approximately 14,000 positions in 2024, primarily in management. They also announced a U.S. network reconfiguration and "Efficiency Reimagined" initiatives in January 2025, which are expected to lead to facility consolidations, workforce reductions, and potential changes to the vehicle and aircraft fleets from 2025 through 2027. These actions are intended to create a more efficient operating model, reduce stranded costs associated with the volume changes (like the Amazon reduction), and enhance responsiveness to market dynamics.
Total revenue in 2024 was relatively flat compared to 2023, at $91.1 billion. However, operating profit decreased by 7.4%, and net income declined by 13.8% in 2024. Operating expenses increased, notably due to higher wage rates for the Teamster employees in the U.S. Domestic Package segment. For 2025, UPS expects revenue to be approximately $89.0 billion, a decrease from 2024, partly due to the accelerated volume reductions from the largest customer. Despite cost-cutting efforts, the expected operating margin for 2025 is around 10.8%, lower than the 2024 reported margin of 9.3% (though non-GAAP adjusted operating margin was 9.8% in 2024).
From an investment perspective, the stock has been trading near multi-year lows, and some analysts see this as the market focusing heavily on the near-term challenges and overlooking the potential long-term benefits of the strategic shift. The current dividend yield is historically high, approaching 7%. While the payout ratio based on GAAP earnings is high, the payout ratio based on free cash flow is lower, offering some comfort regarding the dividend's sustainability, though some still see risk. The valuation multiples (like P/E and EV/EBITDA) are currently below their historical averages, which I see as compelling value if the strategic initiatives are successful.
One valuation measure I like to use is Operating PE (shoutout to Finchat for allowing me to create this custom metric and chart it). As you’ll see below, UPS’s Operating PE has only touched this level twice in the past decade (excluding the COVID panic in March of 2020).
Executing such a large-scale transformation, especially with significant workforce changes and network reconfiguration, comes with risks. There's also the challenge of successfully growing the targeted higher-margin businesses quickly enough to offset the impact of reduced volume from the largest customer and softening demand in other areas. Macroeconomic conditions, labor relations (with a heavily unionized workforce), and global trade policies (like tariffs) are also significant uncertainties that could impact results regardless of internal strategy.
In essence, the investment thesis based on the "Better, Not Bigger" strategy is that UPS is intentionally reshaping its business to focus on more profitable volume and improve efficiency, even if it means lower reported revenue in the short term due to shedding low-margin business like a significant portion of the Amazon volume. The current stock valuation may not fully reflect the potential long-term benefits if management successfully executes this pivot towards higher returns and profitability. However, it's a transition with real risks, and success is not guaranteed.
With a stable divided yield above 6%, in addition to management’s stated goal of buying back $1 billion worth of shares in 2025, we only need modest improvements in EPS (in 2026 and beyond), or modest multiple expansion (UPS’s current P/E is 14.32 vs. 5 year average of 19.15) in order to garner a sufficient return on our investment. It may take 12 to 18 months to generate this return, however, I feel sufficiently confident in UPS’ staying power, moat, and operational priorities to feel good about an investment at this time and at this valuation.