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Is UPS the Best Dividend Stock?

UPS(NYSE:UPS) The current dividend yield of around 4.4% is very attractive for income-seeking investors, but is the payout sustainable? The company’s earnings have been disappointing lately, and dividend coverage for 2024 looks quite thin. Is UPS a Stock Dividend Hunters Can Buy? Here’s what you need to know before you buy the stock.

UPS’s dividend

The trailing twelve months’ dividend cost the company about $5.4 billion, and as you can see below, after a disappointing 2023, free cash flow (FCF) per share didn’t cover last year’s dividend. Clearly, this isn’t a sustainable situation, and investors should buy UPS stock more because of the direction the company is heading than where it just came from.

UPS free cash flow per share chart

UPS free cash flow per share chart

But honestly, last year was an exceptionally bad year for UPS. Delivery volumes fell much more than management expected due to a slowing economy and a natural retreat from the boom of previous years due to stay-at-home measures. In addition, a long-term labor dispute over a contract extension caused customers to give away volumes for fear of strike action.

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Where UPS is going

That said, management’s plans include significantly improving profit margins and delivery volumes and increasing unit sales above unit costs by leveraging technologies such as automation to consolidate facilities and smart facilities to boost productivity improve. In addition, UPS continues to grow small and medium-sized business (SMB) and higher-margin healthcare revenues.

Management targets FCF of $5.9 billion to $6.7 billion by 2024, and ultimately $17 billion to $18 billion between 2024 and 2026. The lower end of that figure would average $5.6 billion per year, which would boost the dividend cover. Furthermore, the guidance appears conservative given the target of $5.9 billion to $6.7 billion (before pension contributions) in 2024 and the goal of achieving approximately $7 billion in free cash flow by 2026. Wall Street analysts expect UPS to achieve $18.3 billion in free cash flow between 2024 and 2026.

Any way you look at it, UPS’s FCF dividend coverage doesn’t look great. However, that didn’t stop CEO Carol Tome from saying the following during the recent earnings call:

We use a target dividend payout ratio of 50%. We are higher than that. Our intention is to earn back to a 50% payout ratio over time.

She went on to say that she had “no intention” of cutting the dividend, with outgoing CFO Brian Newman noting: “We are committed to a stable and growing dividend.”

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It is a confident story from management. Still, it’s hard to see a significant increase in the dividend given the kind of FCF generation management outlined for the coming years.

Is UPS a dividend stock to buy?

The company is in recovery mode in 2024, with management expecting an inflection point in volumes to pass during the year as comparisons with 2023 become easier. In addition, margins should increase as they face the cost increases associated with the new labor contract. in 2023.

A person smiles while sitting in front of a laptop displaying graphs.A person smiles while sitting in front of a laptop displaying graphs.

Image source: Getty Images.

Meanwhile, the technology investments make sense and UPS is already meeting its internal healthcare and SMB revenue growth targets. On the other hand, any economic downturn, especially if there is overcapacity in the package delivery sector, would hit UPS hard and raise serious questions about its capital allocation strategy, starting with the dividend.

On the other hand, recent earnings results confirmed that management expects a “slight increase” in delivery volumes in its domestic operations in the second quarter, which would lead to a low-single-digit increase in the second half. That’s an important number to watch because if it comes through, UPS is on track to muddle through for the next few years while growing its dividend, albeit slowly.

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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.

Is UPS the Best Dividend Stock? was originally published by The Motley Fool

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