Currently yielding 5.1%, shares were bought from UPS(NYSE: UPS) would generate $6,550 in annual income if you invested $100k across the two stocks. While there are question marks surrounding the business and its full-year guidance, the stock still represents excellent value for long-term investors. Here's why.
A blue chip stock like UPS yields 5.1% for a reason, and that depends on some doubt in the market about the company's dividend and/or its ability to grow its dividend. That is understandable. After all, management's stated aim is to pay around 50% of the adjusted amount earnings per share (EPS) in dividends. Unfortunately, with the market expecting just $7.49 in EPS this year, the current dividend of $6.52 equates to 87% of its EPS.
Analysts asked management about the sustainability of the dividend on an earnings call earlier in the year, and CEO Carol Tome insisted, “We have no intention of cutting the dividend just to make that math work. ” In other words, the dividend will not be cut so that UPS can meet its goal of paying a dividend equal to 50% of earnings. Instead, management plans to increase its earnings to get the ratio back to 50%.
Fortunately, there is good reason to believe it can. After a few years of declining package volumes in its core US domestic market, UPS is improving its volumes again, and its revenue is growing.
Data source: UPS submissions. Chart by author.
At the same time, the company is now winding down the increase in labor costs associated with a new contract agreed at the end of a lengthy negotiation last year, making cost comparisons easier in the future. Additionally, UPS made good progress on costs in its domestic segment in the third quarter by reporting a 4.1% year-over-year decrease in cost per piece, which more than offset the 2.2% decline in revenue per piece , leading to margin expansion.
Furthermore, UPS will reduce printing costs by $1 billion by cutting 12,000 jobs in 2024 as it reduces the ability to adapt to market demand.
As outlined in the Investor Day presentation in March, the US small package market moved from a lack of capacity from an average daily volume of 6 million packages during the lockdown to capacity. surplus from an average daily volume of 12 million packages in 2023/2024.
Image source: Getty Images.
The overcapacity is a result of an unexpected shortfall in supply volumes due to persistently high interest rates slowing economic activity (there is also the issue of customers moving to lower cost supply options) and a spillover from the increase in capacity made by the industry to deal with the lack of capacity during the lockdown periods.
Still, numbers are improving, and lower interest rates in 2025 are likely to boost economic activity and, in turn, package supplies.
While the growth in revenue-per-piece deliveries is far from ideal for UPS, this is the reality of the market now, and UPS is struggling through difficult times. That said, management is continuing its long-term and highly successful strategy of focusing on growth in small and medium-sized businesses (SMBs) and healthcare.
For example, Investor Day plans call for UPS to double its healthcare-related revenue from $10 billion in 2023 to $20 billion by 2026. Likewise, management plans to take its penetration into the SMB market the US from 29% in 2023 to 40% over the long term.
Meanwhile, UPS continues to invest in creating the “network of the future” by investing in automation and smart facilities; these investments should improve productivity, enabling UPS to cut costs by consolidating locations.
Image source: Getty Images.
Given the challenges this year, UPS may not meet its full-year guidance, but trading at the current valuation, it's hard not to think the market is already expressing that view in the share price. As such, there could be significant upside to the stock if it meets the guidance.
Thinking longer term, all the elements are in place for a multi-year company recovery, which could mean excellent long-term returns for investors. The improving outlook makes it more likely that UPS will maintain its dividend and seek to increase earnings to reduce the payout ratio. All told, the stock looks like a great value.
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Lee Samaha does not have a position in any of the stocks mentioned. The Motley Fool recommends United Parcel Service. The Motley Fool has a disclosure policy.
