Stalled UPS: 2009 Dividend Boost Not Likely

“What Can Brown Do For You?”

Aside from maybe giving the slogan a rest, how about an increase when they announce their Q4 dividend in the next couple of weeks?

Nice thought, but unfortunately the Brown truck with the dividend boost on board hasn’t made a delivery so far this year, and probably will stay stuck in traffic for a few more months.

United Parcel Service (UPS), by far the higher yielder compared to its worldwide package delivery archrival Fedex (FDX), has either increased or maintained its dividend every year for nearly four decades. And this year there are a couple of reasons “maintain” looks a lot more likely than “increase.”

First, the dividend exhausts about 80% of current earnings, and even though UPS is a well-oiled cash machine it also runs a highly cyclical business with ongoing capital expenditure needs and plenty of debt to service.

That doesn’t mean Brown isn’t healthy: it’s pretty much in the pink. Despite losing its AAA bond rating (hey, didn’t everybody?) bond raters still keep high quality investment grade ratings on UPS, and Morningstar gives them a top grade of ‘A’ for Financial Health. And with Morningstar’s highest “wide moat” rating for sustainable competitive advantages, UPS has a strong business model.

But UPS will sometimes hold onto its cash, and hence the four decades of sometimes maintaining rather than increasing the dividends it ships out to shareholders.

Second point: we saw the same truck stuck in the same traffic a few years ago.

UPS increased its dividend in February 2001, maintained it through the tough 2002 business environment, and then raised it in February 2003. The company broke the February sequence with another increase in August 2003, citing a positive growth outlook and the reduced tax rate on dividends. Then UPS upped the dividend every February until 2009, when it maintained it at its current rate.

I read somewhere that to make sense of their surroundings, humans are hardwired to perceive patterns, even when no patterns actually exist. But I’ll go out on a limb here: I think there’s a pattern.

When UPS gives an annual dividend increase, it happens in February. The last time the company “maintained” in February of a tough year, they didn’t follow up with a year-end U-turn and give an increase.

And they’re in a tough year now. The company’s Thursday earnings release showed shipping volume, revenues, earnings, and margins all down compared to a year ago. And though UPS beat consensus estimates, the market beat its stock down on management’s cautious comments, though it scratched back to flat when the S&P rebounded strongly for the day.

Over the long-haul of a full cycle, UPS shows a 5-year annualized dividend growth rate of 14%, according to Reuters. Recent caution moderated the 3-year growth rate to about 11% and the 1-year rate to a further declining though still-decent 7%. Cash flow easily covers the dividends, but earnings need to improve markedly to get in line with dividend payments.

Based on Morningstar data, UPS’ P/E is cyclically high: it’s more about really low E than a high P. The Price to Cash Flow ratio is attractively low. ROE looks excellent at 23%, but is pumped up by long-term debt to equity of 130%. Return on Capital is cyclically depressed below 8%, but also below the industry average and the market, according to MSN Money.

And UPS’ stock price hasn’t exactly been a joyride, barely staying on the moneymaking side of the road this year, while the S&P 500 is up some 20%. The stock also lagged the market and the Industrial Sector ETF (XLI) over the trailing 5-year period, though it has made a better showing over the trailing 1-year and 2-year periods.

In fairness, some analysts have upgraded the stock recently, perhaps anticipating a cyclical turbo-charge, and Morningstar just published an optimistic note.

Overall, investors with strict requirements for annual dividend increases, economic bears and those fearing spiking oil prices will likely refuse delivery on UPS shares.

But those with the audacity of lingering hope, who are willing to ride out the bumps high quality cyclical companies simply endure? They stand to collect solid dividends, a nearly 3.2% yield right now, that probably will increase in February if the global economy gets moving.

And maybe a second 2010 dividend increase, just like in 2003? That might be too much to ask even Brown to do for you.

For a look at a very high quality company that also froze its dividend in 2002 then resumed annual increases until this year, see my Seeking Alpha article “Strong Cash Flow and Superb Operation Back Paychex Dividend” (PAYX).

References and Links

Morningstar, UPS Ratings and Grades

Yahoo Finance, UPS Historical Dividends, through 2009

Yahoo Finance, “United Parcel Service, Upgrade and Downgrade History,” 2009.

Morningstar Stock Analyst Notes, “Cause for Optimism in UPS' 3Q Results,” October 22, 2009.

Seeking Alpha, “Strong Cash Flow and Superb Operation Back Paychex Dividend,” October 14, 2009.

Disclosure: Long PAYX, UPS