As part of my investment strategy, I sometimes like to buy great dividend stocks in the middle of a turnaround, which brings me to logistics giant United Parcel Service (UPS). The company benefited from a surge in parcel volumes due to the COVID-19 pandemic. However, that turned out to be a temporary windfall and the shares are down 31% in the past three years.
I believe this sell-off could be an opportunity for shareholders to buy into a company with a solid dividend yield and capital growth prospects, especially as UPS’s recent financial results offered hope that its plan to return the company to growth will actually be able to grow before the corona crisis. work. As a result, I am initiating coverage on the stock with a buy rating.
On October 24, UPS shared third-quarter earnings results that were constructive to my bullish thesis. The company’s total revenue increased 5.6% year over year to $22.2 billion. For perspective, this came in just above the analyst consensus of $22.1 billion and was led by $1.1 billion (6.5%) volume growth in the company’s US domestic segment. Additionally, sales were only partially offset by a $300 million (2.2%) decline in unit sales.
In addition, UPS’s adjusted earnings per share rose 12.1% from the prior-year period to $1.76. This easily exceeded the analyst consensus of $1.63. Through cost management, the company’s unit costs in the U.S. domestic segment fell 4.1% in the quarter. This helped UPS’ non-GAAP net profit margin increase by nearly 40 basis points to 6.8% and explains how adjusted earnings per share outpaced overall revenue growth.
UPS’s continued actions appear poised to continue the return to growth in the coming quarters, reinvigorating my optimism. The company’s Fit to Serve program, which is designed to optimize and tailor its management structure, is making good progress. The company aims to reduce 12,000 positions to adapt to changing market dynamics.
According to CEO Carol Tome, this is slightly ahead of schedule. UPS’s Network of the Future initiative is also making strides in the right direction, with 45 operational closures, including nine entire buildings closed this year. This initiative is expected to save $3 billion by the end of 2028 by shifting volume to automated parcel hubs.
Additionally, UPS’s U.S. domestic daily volume is trending in the right direction, as evidenced by its second consecutive quarter of growth. For more context, the third quarter of 2024 saw the highest annualized average daily volume growth since the first quarter of 2021. This combination of top and bottom-line performance explains why analysts expect adjusted earnings per share to increase by 16.8 in 2025 % will rise to $8.76 and by 14.7%. % to $10.05 in 2026.
UPS’s outsized dividend yield is another factor I like about the stock. This is because the 4.9% return is about four times greater than the 1.2% of the S&P 500 index (SPY). That means investors can be patient with UPS as it continues to execute on its strategy to return to consistent growth.
Meanwhile, the dividend also seems to be quite safe. Assuming a token 0.6% increase in quarterly dividend per share to $1.64 for 2025, the adjusted earnings per share payout ratio would be around 75%. By 2026, the payout ratio could improve further to less than 66%. In my view, this creates a path for UPS to start delivering small annual dividend growth starting in 2027, which would arguably be a nice mix of immediate earnings and future earnings.
Despite the ongoing turnaround, UPS’s financial health is another positive that supports my optimistic view. The company’s interest coverage ratio for the first nine months of 2024 was 24.4 times. For more color, this is considerably lower than the interest coverage ratio of 43.3 a year ago.
Nevertheless, as cost-saving efforts become fully visible in the coming quarters, this interest coverage ratio should rise again quickly.
In any case, UPS’s interest coverage ratio in its current form already points to a company that can meet its financial obligations without entering a solvency crisis. That is why the company has an A credit rating from S&P Global (SPGI).
Despite UPS’s progress, the company still appears undervalued. That’s yet another reason behind my optimism about the stock. UPS’s forward price-to-earnings ratio of 15.2 is lower than its 10-year average price-to-earnings ratio of 18.4. As the company continues its cost-cutting programs and growth recovers, I believe the valuation ratio could return to the high teens, providing an opportunity for upside.
As for Wall Street, analysts have a Moderate Buy consensus rating on UPS. Of the 19 analysts, eight have assigned a Buy rating, ten a Hold rating and one a Sell rating in the past three months. Furthermore, the twelve-month average price target of $143.12 per share implies that UPS could appreciate 7.39% in value from the current price level.
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The financial markets are skeptical about rewarding UPS with a higher valuation multiple just yet. However, I suspect that as the company delivers healthy results in 2024 and 2025, the narrative could quickly change in UPS’s favor. While I wait for this to play out, I’m content to collect market-crushing earnings with modest future growth potential. For these reasons, I’m starting coverage with a buy rating for UPS.
Revelation
