2023-11-13 06:01:52 ET
Summary
- UPS stock has experienced a 40% sell-off, impacting its total return picture over the past ten years.
- The company's dividend yield is now 4.7%, with a 64% payout ratio and uninterrupted dividend growth since the Great Financial Crisis.
- UPS is strategically adapting to market dynamics through acquisitions and innovations in healthcare logistics and e-commerce returns.
Introduction
I could have sworn that I wrote an article on the United Parcel Service (UPS) this year. However, on August 6, I covered its peer, FedEx (FDX). Back then, I wrote an article titled 90% Off Its Lows - Sell FedEx, Buy Better Compounders Instead .
In that article, I wrote that FedEx had an unfavorable risk/reward for my taste. Not because it's a poor company (it's one of the best shipping companies in the world) but because of its extremely cyclical behavior. The moment shipping demand falls, companies see a steep decline in margins.
The same applies to UPS but to a lesser extent, which is why I thought I had covered the stock earlier this year. Both are very similar when it comes to the impact of a slowing economy on their businesses.
If it weren't for the current 40% sell-off, UPS would have beaten the S&P 500 going back to the year 2000.
Yes, that's right. UPS is down 40% (39% actually) from its all-time high reached in January 2022.
This sell-off is so bad that it ruined the company's total return picture of the past ten years.
Using the data below, we see that:
- UPS has returned 6.9% per year over the past ten years (including dividends). The S&P 500 has returned 11.0% per year.
- UPS has returned 9.1% per year over the past five years. While the S&P 500 performance wasn't much worse, UPS had a standard deviation of more than 30%.
- The three-year performance is way worse than the market, caused by current economic headwinds.
Nonetheless, while I am not necessarily a fan of this industry, UPS continues to be a fantastic, high-quality company that can deliver terrific returns when bought at the right price.
Hence, in this article, I'll walk you through the company's recent performance and assess the risk/reward and attractiveness of UPS as a long-term investment at current prices.
So, let's get to it!
A Juicy Yield
One of the best things about UPS's stock price decline is the fact that its dividend yield is now 4.7%. This dividend also comes with a very "green" Seeking Alpha dividend scorecard.
The company's juicy yield is protected by a 64% payout ratio. It has a five-year CAGR of 12.2% and uninterrupted dividend growth since the Great Financial Crisis when the dividend remained stable.
As we can see in the chart above, the five-year dividend growth performance is highly impacted by the pandemic.
- On January 31, the company announced a 6.6% hike.
- On February 1, 2022, the company hiked its dividend by 49%!
If we adjust for the pandemic, annual dividend growth since the Great Financial Crisis has been in mid-single-digit territory, which is very decent for a stock that now has a yield close to 5%.
It's The Economy...
At the end of October, UPS gave us a look into its business when it reported third-quarter earnings.
Unsurprisingly, the company noted that the U.S. domestic sector faced tough conditions, including volume diversions from the second quarter continuing into the third quarter.
Demand is so weak that both UPS and FDX have bought out pilots who are now switching to passenger airlines.
Nearly 200 senior pilots at UPS have accepted the company's voluntary severance package, and regional passenger airline PSA Airlines is trying to recruit them to close a crew shortage.
The headcount reduction at UPS Airlines is much more limited than one envisioned at rival FedEx Express, where management has acknowledged it has more than 700 excess pilots and on Friday urged flight crews to quit for the same type of offer at PSA Airlines, an American Airlines subsidiary that operates in the Eastern half of the United States.
UPS in late August offered early retirement to veteran pilots as part of an effort to reduce costs in the face of shrinking parcel volumes.
Furthermore, challenges included delayed volume returns after the Teamster contract ratification in September and increased labor costs due to the new contract.
Despite difficulties, efforts were made to adjust the network, manage costs, and bring volume back.
As a result, consolidated revenue in the third quarter was $21.1 billion, down 12.8% from the previous year, which could have been worse.
- Consolidated operating profit was $1.6 billion, down 48.7%, with an operating margin of 7.7%.
- Diluted earnings per share for the quarter were $1.57, a 47.5% decrease from the same period last year.
To add some more context to these numbers, in the U.S. domestic segment, average daily volume was down 11.5%, with volume diversion reducing volume by approximately 1.5 million packages per day.
Revenue per piece increased by 2%, driven by strong base rates and improved customer and product mix. Total expense was down 5.1%, and U.S. domestic generated an operating profit of $665 million, down 60.6%.
In the International segment, total average daily volume was down 6.6%, with declines in domestic and export volume, particularly in Asia and Europe.
International revenue was $4.3 billion, down 11.1%, with a 15.8% operating margin.
Supply Chain Solutions revenue was $3.1 billion, down $854 million, influenced by factors like softer global demand in international air freight and excess market capacity in truckload brokerage.
The segment generated an operating profit of $275 million, with an operating margin of 8.8%.
After having thrown all of these numbers at you, it's fair to make the case that UPS is making the best of a very challenging situation. For example, the revenue per unit/piece showed a promising improvement, yet not even close to enough to offset volume-related weakness.
As a result, UPS is continuing to improve its business.
Business Improvements
I own three railroads in my dividend growth portfolio. That's my preferred way to invest in transportation. Like UPS, these companies are currently struggling with weak volumes.
Hence, they focus on areas they can improve. This includes working on new long-term deals with companies, improving operations, and related activities.
UPS is doing the same.
For example, the company is buying companies in niches with promising growth.
Recent acquisitions, including MNX Global Logistics, align with UPS's goal to become the number one healthcare logistics provider globally.
According to the company, investments in dedicated healthcare facilities and strategic acquisitions strengthen its position in the healthcare market.
MNX has a strong track record in providing reliable and timely delivery of critical goods. The company's expertise in transporting radiopharmaceuticals and temperature-sensitive products will help UPS Healthcare and its clinical trial logistics subsidiary, Marken, meet the growing demand for these services in the healthcare industry. - UPS
Furthermore, with the surge in e-commerce, UPS's returns business is a key growth area. The acquisition of Happy Returns aims to provide a frictionless returns experience, leveraging UPS's extensive network and locations.
As reported by FreightWaves :
Founded in 2015 and based in Los Angeles, Happy Returns specializes in no-box, no-label returns. It works with about 800 merchant consumers to facilitate the returns process. UPS will pick up and deliver all returned items.
The transaction expands UPS' footprint in the fast-growing online returns segment. Demand for returns management solutions has increased along with e-commerce activity. Online returns is a different and more complex process than the traditional return-to-store transaction because there is no fixed store location to accept returned items. In addition, consumers increasingly order multiples of the same product, decide to keep one item and return the rest.
Another thing the company has been working on is the enhancement of the delivery experience with features like UPS delivery photos, reducing support requests by over 15%.
UPS is also exploring robotics, such as robotic unloading technology, for more efficient package handling.
These innovations include Dexterity, Fortna, and Plus One Robotics-powered pick-and-place technologies. These pick-and-place robots help employees sort small packages, which require many repetitive movements and can be inconsistent and it flexes with customer demands.
UPS also uses Pickle Robot's unloading technologies to ease the labor-intensive job of unloading trailers. Pickle's robot eases the workload off of workers and delivers better package care and reliability for UPS customers. - The Robot Report
So, what about the outlook?
Outlook & Valuation
Like every year, UPS is gearing up for the peak season, collaborating with customers on volume projections and leveraging technology to ensure efficient operations.
This year, over 100,000 seasonal employees will be hired, with streamlined and faster application processes.
However, while healthy peak volume is expected in Q4, the financial outlook was revised lower based on perceived slowing demand across business segments.
Consolidated revenue is expected to come in between $91.3 and $92.3 billion, and consolidated operating margin between 10.8% and 11.3%.
As one can imagine, these assumptions include demand softness, challenges in the consumer market, and weak forwarding demand.
With regard to these economic comments, there is some light at the end of the tunnel. The Logistics Managers' Index has increased for three straight months.
Needless to say, economic risks are very persistent, and the biggest improvement seems to come from inventory reductions and adjustments after shippers brought way too much equipment online during the pandemic.
Whether increased inventories are temporary bursts of seasonal expansion or the sign of a larger move back towards stronger economic growth remains to be seen. What we can say however is that October's inventory and overall index scores are a marked step forward for the logistics industry. - LMI
Having that said, using the data in the chart below, the risk/reward isn't half bad. Not only is the dividend yield juicy, but investors have priced in a lot of weakness.
- After dropping roughly 40% from its high, UPS is trading at a blended P/E ratio of 14.7x.
- Since 2002, the stock has traded at a normalized P/E ratio of 20.1x.
- However, in times of economic headwinds, the valuation tends to be subdued for multiple years. This happened during the Great Financial Crisis, the 2011/2012 debt crisis, the 2018 global economic slowdown, and the current economic downtrend.
- This year, EPS is expected to decline by 32%, followed by 10% and 13% growth in 2024 and 2025, respectively.
- Six months ago, analysts expected full-year EPS in 2023 to decline by 17%, which shows how much weakness has been priced in over the past few months.
Based on these numbers, the stock has a potential fair value of $221, which is 60% above the current price. The current consensus price target is $166.
Nonetheless, I cannot make the case that UPS is a must-own stock.
- The company's performance is similar to the S&P 500, with steeper downturns and elevated volatility.
- It's a capital-intensive business that could be prone to disruption.
- It also failed to outperform the transportation ETF ( IYT ).
The ratio between UPS and IYT (including dividends) shows that investors need the right timing to make a difference. In general, it's hard for UPS to outperform IYT. UPS has a 14% weighting in this ETF.
Nonetheless, UPS is down 40%. It's doing well when it comes to enhancing efficiencies, and I doubt that disruption will derail the bull case.
Given the valuation, investors interested in buying transportation stocks with a high yield and consistent dividend growth may benefit from buying in intervals.
However, buying deep corrections with elevated recession risks isn't a walk in the park. We could see another 12 months without meaningful upside or even more losses if the Fed fails to fight inflation without sacrificing the economy.
So, please keep that in mind.
Given the risk/reward, I will give the stock a long-term Buy rating. However, as I said, this is no guarantee that we're at the very bottom.
Five years from now, I have little doubt that UPS will trade much higher. One year from now, I'm not so sure.
Takeaway
Despite a 40% stock drop, UPS maintains its status as a high-quality company. The recent 4.7% dividend yield, supported by a 64% payout ratio, presents an attractive opportunity for investors.
UPS strategically adapts to market dynamics, evidenced by acquisitions in promising niches and innovations in the delivery experience.
The company's focus on efficiency and growth, particularly in healthcare logistics and e-commerce returns, positions it for long-term success.
While economic uncertainties persist, UPS's potential fair value of $221 suggests an appealing investment opportunity, though caution is advised in light of economic challenges.
For further details see:
Down 40%, 5%-Yielding UPS Is Getting Attractive