Package delivery giant UPS‘s (UPS 0.04%) 4.6% dividend yield attracts many income-seeking investors, and value investors are also on board, given the company’s low valuation. This company deserves a close look by investors, so here are three factors to consider before diving in.
1. UPS’s dividend is sustainable if…
Whenever anyone finds a high-yield stock, it’s essential to consider whether its dividend is sustainable. Since dividends tend to be paid out of free cash flow (FCF), it makes sense to start there.
UPS’s trailing FCF of $5.56 billion doesn’t provide much cover for its $5.3 billion payout. An observation that leads to the first point: UPS’s dividend is sustainable, provided that 2023 is in fact a trough year.
Fortunately, the case for UPS improving its earnings and cash flow next year is a good one. UPS was hit with declining package delivery volumes due to a slowing economy.
In addition, the distorting impact of protracted labor negotiations hurt UPS earnings this year. Not only did the eventual five-year contract create $500 million worth of up-front expenses in the third quarter alone, but the protracted negotiations led customers to divert deliveries to other networks.
However, the labor issues are unlikely to repeat in 2024, and the company will face easier comparisons with trading this year. As such, this year will likely prove a trough in UPS’s earnings.
2. UPS investors will need patience
While Wall Street expects UPS’s sales and earnings to improve next year, it will take time for its quarterly earnings to grow again. Management lowered its full-year 2023 sales and earnings guidance on the third-quarter earnings call, and CFO Brian Newman said, “Headwinds are mounting for the consumer in the fourth quarter.”
These headwinds mean analyst estimates assume UPS earnings won’t increase on a quarterly year-over-year basis until the third quarter of 2024. As such, investors must be patient before seeing a quarterly report showing earnings growth. That might be a concern for investors.
3. UPS’s underlying business is improving
Perhaps the most important consideration for investors is that UPS is improving the underlying quality of its business. This is most easily seen in two areas relating to its revenue.
The first is the conscious decision to be more selective over deliveries rather than chasing volume growth. It’s a decision part of CEO Carol Tome’s “better, not bigger” approach. UPS’s decision to allow for the reduction of less profitable deliveries from Amazon is an example of this. Tome discussed this in the summer of 2022 when she stated:
We’ve contractually agreed on what makes sense for us versus what makes sense for them. That means that both volume and revenue for Amazon is coming down. We project by the end of this year that Amazon revenue will be less than 11% of our total revenue.
Second is that UPS made great strides in expanding its connections with small and medium-sized businesses (SMB) and healthcare customers, and it’s been able to grow its revenue per piece significantly in recent years.
However, it’s also essential to consider the opportunity UPS has to reduce costs by investing in technology. Examples of this come from its investment in smart facilities. UPS had smart technology in 50% of its buildings in the summer, and Tome claimed, “50% of those buildings have misload improvements from 1-in-400 to now 1-in-1,000.” By the fall, Tome could disclose that 200 of its buildings had misload (or loading error) rates of 1-in-2,500 or better.
Moreover, the second phase of its smart package-focused deployment is underway, whereby UPS delivery vans (the company refers to them as cars) can scan packages instead of relying on preloaders. The benefit is that packages can be scanned upon pickup.
In addition, UPS has increased its share of volume going through automated facilities from 53% in 2022 to at least 57% in 2023, and it’s working on using robots to unload packages.
UPS: A stock to buy
Taking all this together, UPS appears to be a very attractive stock for long-term investors, but it will take time to see the full benefits of management’s actions in terms of generating earnings growth again. As such, the stock will suit patient investors willing to accept the possibility of some near-term volatility.
John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Lee Samaha has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Amazon. The Motley Fool recommends United Parcel Service. The Motley Fool has a disclosure policy.