2023-08-04 17:02:56 ET
Summary
- I am selling my stake in UPS because of a forecasted drop in operating income, a less well-covered dividend, and an unappealing share price.
- I think there are better risk adjusted returns to be had elsewhere. In the relativistic game of investing, that matters a great deal.
- My forecast for revenue for the first six months of 2023 aligns closely with Wall Street's analysts, which is disconcerting.
It’s been a little over a year since I pulled the proverbial trigger and bought United Parcel Service, Inc. ( UPS ), and in that time, the shares have returned about 3.2% against a gain of 17% for the S&P 500. I thought I’d check back in on the investment to see if it makes sense to buy more, hold, or sell my stake and look for greener pastures. I’ll make that determination by looking at the most recent financial results, by forecasting upcoming operating income, and by looking at the valuation. I want to get across the idea that I’m not seeking “returns”, I’m seeking “risk adjusted returns”, so if I find an alternative that offers similar returns to this stock at less risk, I’m going to jump on it.
If you’re someone who wants a little bit more than you get from a title, and bullet points, but wants less “Doyle mojo” than you’d get from a full article, I have a solution for you, and that solution is my “thesis statement” paragraph. This paragraph gives you the gist of my thinking in a nutshell. After reading this, you can continue into the labyrinth of my reasoning, or you can get out and do something more productive with your day. I write these because I’m absolutely obsessed with making your reading experiences as pleasant as possible. You’re welcome. I’ll be selling UPS today for a few reasons. First, I’m forecasting a fairly substantial drop in operating income. While I think the dividend is still reasonably well covered, it’s certainly less well covered now than when I gushed about it last year. Speaking of the dividend, when I last reviewed the name, the risk premia was “only” negative 30 basis points and today, it’s about 140 basis points. So, investors are receiving less income from this risky business than they would from a risk free government bond. Finally, the share price is hardly compelling in my view. All of this leads me to conclude that it’d be prudent to take my capital off the table here. The shares may spike higher from here, but that's largely irrelevant in my view. The risk of owning this stock is too great in my estimation, especially given the available options.
Financial Snapshot
The first quarter of the year has been pretty soft in my estimation. Revenue, operating profits, and net income during the first quarter of 2023 were lower by 5.9%, 22%, and 28.8% respectively when compared to the same period in 2022. At the same time, the capital structure deteriorated pretty substantially over the past year, with long term debt and leases higher by about $307 million, and cash and marketable securities lower by about $3.14 billion. I think the dividend remains reasonably well covered, but the payout ratio has leapt from 48% last year to 71% this year. That’s a disturbing trend in my view, and unless income improves markedly, there won’t be much room for dividend growth.
Forecasting Operating Income
When I forecast operating income, I assume that trends are going to persist. This may be a faulty assumption, but I think it’s a reasonable base case. So, revenue in Q1 of 2023 was 5.96% lower than it was in Q1 2022, so I’m going to assume revenue for the first half of the year will drop by the same percentage. The same goes for costs. Given that, I’m forecasting a drop of operating income of about $1.55 billion, or 29.7%. Most of this drop is a function of my forecasted $2.9 billion drop in revenue, and operating income slides in spite of a $2 billion reduction in the purchased transport expense. None of this fills me with a tremendous amount of confidence, and I think interest expense will be even higher this year than last, so net income will drop materially in my estimation.
I should also point out that my forecast is reasonably close to that offered up by Wall Street’s analysts. I’m forecasting revenue for the first six months of the current fiscal year of $46.214 billion, while they’re forecasting $46.05 billion for the first half of the year. I’m not going to lie. It feels a bit disconcerting to be a bit more optimistic than Wall Street, a place not known for excessive pessimism.
UPS Operating Income Forecast (Author forecast)
I’d be happy to continue to own the stock, but it’d have to be reasonably priced.
UPS Financials (UPS investor relations)
The Stock
As you know if you’re one of my regular readers, I’m about to wax (not at all poetically) about the fact that I consider the business and the stock that supposedly represents the business to be two distinctly different things. The business makes money by delivering packages, and operates a logistics, freight, air freight operation etc. The stock, meanwhile, is a piece of virtual paper that gets traded around in a public marketplace, and its movements are driven by the crowd's ever-changing moods about the future. The mood can be impacted by the waxing and waning of the overall demand for "stocks" as an asset class. The mood can be impacted by short term interest rates. For those who don't believe me on this score because they've been convinced that "we don't buy stocks, we buy businesses", consider an investment in UPS at different times.
Let's assume that someone decided to buy on July 26, and another person decided to buy virtually identical shares two days later. The person who bought on July 26 is down about 1% as of this morning, while the person who bought two days later is down 4%. Not enough happened at the firm to account for this 3% variance in returns over two days. We should note that the person who bought the shares more cheaply did less badly. I like cheap stocks because they offer the greatest combination of higher returns at lower risk. They represent the potential for higher returns because any bit of good news may very well send shares higher when only bad news has been "priced in." They represent lower risk because at some point, the market just expects terrible results, so the stock doesn't have much farther to fall. This tendency on my part to buy when the crowd is most pessimistic is a way of playing against crowd expectations.
As my regular readers know, I measure "cheap" or "low expectations" in a few ways, ranging from the simple to the more complex. On the simple side, I like to look at the ratio of price to some measure of economic value, like sales, book value, and the like. I want to see a company trading at a discount to both its own history and the overall market. When I last reviewed UPS, I bought the shares because the PE was sitting at about 14.4, and the dividend yield was at about 2.9%. The shares are sitting very near the same valuation, though the yield for someone who comes to the stock today is about 30 basis points lower, per the following:
Source: YCharts
Source: YCharts
The issue here is that at the time I bought shares last July, the 10-year Treasury Note was yielding about 2.9%. Today, the risk free rate is sitting at about 4%. This means that the risk premium for this stock has moved from negative 30 basis points last year to 140 basis points today. I’m not generally a fan of taking on the risk of stock ownership, and receiving less than I could get on a risk free government bond. Given all of the above, I’m going to be selling my UPS shares today.
For further details see:
Selling United Parcel Services