Currently yielding 5.1%, purchased shares of UPS (NYSE:UPS) would generate $6,550 in annual income if you invested $100,000 in both stocks. While there are questions about the company and its full-year prospects, the stock still represents excellent value for long-term investors. This is why.
A blue chip stock like UPS is yielding 5.1% for a reason, and that reflects some market skepticism about the company’s dividend and/or its ability to grow its dividend. That’s understandable. After all, management’s goal is to pay out approximately 50% of adjusted earnings per share (EPS) as dividends. Unfortunately, with the market only expecting $7.49 in earnings per share this year, the current dividend of $6.52 is equal to 87% of earnings per share.
Analysts asked management about dividend sustainability during an earnings call earlier this year, and CEO Carol Tome insisted, “We’re not looking to cut the dividend just to make that math work.” In other words, the dividend will not be cut so that UPS can achieve its goal of paying a dividend equal to 50% of profits. Instead, management plans to increase profits to bring the ratio back to 50%.
Fortunately, there are good reasons to believe that this is possible. After a few years of declining package volumes in the key US domestic market, UPS is once again improving volumes and growing revenue.
At the same time, the company is now taking advantage of the increase in labor costs associated with a new contract agreed last year at the end of lengthy negotiations, making cost comparisons easier in the future. Additionally, UPS made good progress on costs in the domestic segment in the third quarter, when it reported a 4.1% year-over-year decline in unit costs, outpacing the 2.2% decline in turnover per unit, which resulted in an expansion of the margin.
In addition, UPS will reduce printing costs by $1 billion by cutting 12,000 jobs by 2024 as it reduces capacity to adapt to market demand.
As detailed in the Investor Day presentation in March, the US small package market went from a capacity shortage of an average daily volume of 6 million packages to a capacity shortage of 6 million packages per day during the lockdown period. surplus of an average daily volume of 12 million parcels in 2023/2024.
The overcapacity is due to an unexpected shortage of delivery volumes due to persistently high interest rates that slow down economic activity (there is also the problem of customers switching to cheaper delivery options) and a spillover effect from the capacity increase that the sector has implemented to solve the problems to catch. capacity shortage during the lockdowns.
Nevertheless, volumes are improving and lower interest rates are likely to stimulate economic activity and thus parcel delivery in 2025.
While the growth of deliveries with lower unit yields is far from ideal for UPS, it is now a reality in the marketplace, and UPS is struggling through a difficult period. That said, management continues its highly successful long-term strategy focused on growth in small and medium-sized enterprises (SMEs) and healthcare.
For example, the Investor Day plans call for UPS to double its healthcare-related revenues from $10 billion in 2023 to $20 billion by 2026. Similarly, management plans to reduce its penetration of the U.S. SMB market from 29% by 2023 to 40% in 2023. 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, allowing UPS to save costs by consolidating locations.
Given the challenges this year, UPS may not meet its full-year expectations, but based on its current valuation, it’s hard not to think the market is already expressing that view in the stock price. As such, the stock could have significant upside if it meets guidance.
Looking longer term, all the elements are in play for a multi-year business 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 earnings growth to lower its payout ratio. All in all, the stock appears to be an excellent value.
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Lee Samaha has no positions in the stocks mentioned. The Motley Fool recommends United Parcel Service. The Motley Fool has a disclosure policy.
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