How Amazon is Helping UPS in its Business

Summary

• UPS is the largest package delivery company in an industry where size does matter.
• Through its success, Amazon is stimulating the eCommerce industry, inviting many retailers to use UPS delivery services.
• Buying shares of UPS is a less volatile move than buying shares of AMZN.

As Amazon (AMZN) grows its revenue, its delivery demand increases accordingly. While Amazon is building its own truck & drone army to deliver its goods, I don’t think it is a threat to UPS (NYSE:UPS) and other delivery companies; I think it’s an opportunity. I believe UPS can use this situation to its advantage. In a short-term perspective, UPS will continue to deliver for Amazon as their internal delivery operations won’t grow fast enough to meet their needs. In a long-term vision, UPS will continue to grow their revenues from international shipping coming from other eCommerce retailers. Amazon is somewhat inducing all classic brick & mortar retails such as Wal-Mart (WMT) and Target (TGT) to massively invest in their online platform where is where the customers want to shop now. This naturally increases the amount of package delivery demands. Let’s take a deeper look at UPS as a potential investment.

What Makes UPS a Good Business?

UPS is the world’s largest package and delivery company. In 2016, it delivered 4.9 billion packages and documents - 19.1 million daily - and generated $51 billion in revenue. UPS has evolved in an industry where size does matter. This enables the company to have a larger distribution network and offer clients more flexibility in their delivery options. Through economies of scale and tight management, UPS is not only the largest delivery company, but it also shows the strongest margin of the industry:

Source: UPS presentation

Surprisingly enough, UPS keeps finding new ways to minimize their operational costs. Their latest cost cutting & optimization plan is expected to save up to $1 billion.

Source: UPS presentation

Revenue

Revenue Graph from Ycharts

Since the 2009-2010 recession, UPS revenue growth has followed a steady uptrend. Revenues were boosted by the economy getting better and online shopping increasing. The company has positioned eCommerce and exportation as their growth vector for the years to come:

Source: UPS presentation

How UPS fares vs. My 7 Principles of Investing

We all have our methods of analyzing a company. Over years of trading, I’ve been through several stock research methodologies from various sources. This is how I came up with my 7 investing principles of dividend investing. Let’s take a closer look at them.

Source: Ycharts

Principle #1: High Dividend Yield Doesn’t Equal High Returns

My first investment principle goes against many income seeking investors’ rule: I try to avoid most companies with a dividend yield over 5%. Very few investments like this will be made in my case (you can read my case against high dividend yield here). The reason is simple; when a company pays a high dividend, it’s because the market thinks it's a risky investment, or that the company has nothing else but a constant cash flow to offer its investors. However, high yields hardly ever come with dividend growth and this is what I am seeking most.

Source: data from Ycharts.

UPS’s dividend yield has remained between 2.50% and 3% most of the time since 2010. As the stock price increases, we can see a steady dividend growth trend keep a steady yield. The stock shows a stable and reasonable yield and therefore, UPS meets my 1st investing principle.

Principle#2: Focus on Dividend Growth

Speaking of which, my second investing principle relates to dividend growth as being the most important metric of all. It proves management’s trust in the company’s future and is also a good sign of a sound business model. Over time, a dividend payment cannot be increased if the company is unable to increase its earnings. Steady earnings can’t be derived from anything else but increasing revenue. Who doesn’t want to own a company that shows rising revenues and earnings?

Source: Ycharts

UPS isn’t part of any elite dividend grower group yet as it only has had 7 years with a consecutive dividend yield. As you can see in the next chart, the company had to halt their dividend increase in 2009 due to a difficult economic environment.

Source: UPS presentation

Since then, the dividend payout has been on a steady uptrend year after year. At this pace, the company will definitely becomes a dividend achiever in 2019.

UPS meets my 2nd investing principle.

Principle #3: Find Sustainable Dividend Growth Stocks

Past dividend growth history is always interesting and tells you a lot about what happened with a company. As investors, we are more concerned about the future than the past. This is why it is important to find companies that will be able to sustain their dividend growth.

Source: data from Ycharts.

As you can see, UPS has maintained a steady payout and cash payout ratio for the past 8 years. This year, the cash payout ratio increased significantly due to a lump sum contribution to the UPS pension plan. From their SEC Filing Q1 2017:

“During the first three months of 2017, we contributed $2.312 billion and $177 million to our company-sponsored pension and U.S. post-retirement medical benefit plans, respectively. We also expect to contribute $65 and $64 million over the remainder of the year to the pension and U.S. post-retirement medical benefit plans, respectively”

While this tells me I will have to take a close look at UPS employees benefit cost in the future, I expect the cash payout ratio to return to normal in the years to come. In other words; the dividend payout is safe for now.

UPS meets my 3rd investing principle.

Principle #4: The Business Model Ensure Future Growth

As more customers shop online, delivery is and will remain a solid business in the years to come. With UPS being the largest player in this industry, it is able to generate larger economies of scale and cover more areas than Amazon eventually could.

One problem addressed with eCommerce is the higher delivery cost associated with such businesses. Instead of shipping a truckload of goods to a single destination, the UPS truck has to make a thousand stops at individual houses. In order to optimize their practice and minimize their cost, UPS is working on steering customers toward alternative delivery locations:

UPS Fact sheet

UPS still shows a strong business model and meets my 4th investing principle.

Principle #5: Buy When You Have Money in Hand - At The Right Valuation

I think the perfect time to buy stocks is when you have money. Sleeping money is always a bad investment. However, it doesn’t mean that you should buy everything in sight just because you have some savings set aside. There is valuation work to be done. In order to achieve this, I will start by looking at how the stock market valued the stock over the past 10 years by looking at its PE ratio:

Source: data from Ycharts.

At first, I wasn’t too excited by UPS’ high PE ratio. While the market as a whole is trading at a high average PE ratio, UPS is helping the average up. However, looking at the 10-year history, I notice that investors usually value UPS at a high valuation. Right now, UPS doesn’t look like it is trading cheap, but it doesn’t look too expensive either.

Digging deeper into this stock valuation, I will use a double stage dividend discount model. As a dividend growth investor, I would rather see companies as big money-making machines and I assess their value as such. I’ve used a 6.5% dividend growth rate for the first 10 years to match recent hikes. I then reduce the growth rate to 6% to be more conservative.

Here are the details of my calculations:

Source: Dividend Monk Toolkit Excel Calculation Spreadsheet

The DDM valuation seems a bit high compared to the current PE ratio. However, the company clearly shows a strong dividend growth profile for the years to come and I think the true fair value of UPS is standing somewhere between the current value and the DDM calculation at $141.43.

UPS meets my 5th investing principle with a potential upside of 29%

Principle #6: The Rationale Used to Buy is Also Used to Sell

I’ve found that one of the biggest investor challenges is to know when to buy and sell one’s holdings. I use a very simple, but very effective rule to overcome my emotions when it is time to pull the trigger. My investment decisions are motivated by the fact that the company confirms or does not confirm my investment thesis. Once the reasons (my investment thesis) why I purchase shares of a company are not valid anymore, I sell and never look back.

Investment thesis

With the recent purchase of Whole Foods by Amazon, the war against brick & mortar retailers has never been more intense. While WMT, TGT, AMZN and other will fight on tight margins, companies like UPS will rise and deliver all those retailers goods. Since UPS is the largest player in this arena, it will continue to benefit from the uptrend in the delivery business.

UPS evolves into a more stable and predictable business than a techno like AMZN and the company already pays a solid dividend. The company has been known for decades to be extremely efficient and I believe management will find a way to improve the current “too-many-delivery-stops” environment online shopping had created.

UPS shows a solid investment thesis and meet my 6th investing principle.

Principle #7: Think Core, Think Growth

My investing strategy is divided into two segments: the core portfolio, built with strong & stable stocks meeting all our requirements, and the “dividend growth stock addition” where I may ignore one of the metrics mentioned in principles #1 to #5 for a greater upside potential (e.g. riskier pick as well).

As previously mentioned, UPS shows a solid business model with predictable growth. While the company can count on online shopping and international shipping as growth vectors, you can’t expect UPS to burst out with an impressive growth. This is the kind of company that is better off used to stabilize your portfolio with a nice and steady dividend.

UPS is a core holding.

Final Thoughts on UPS – Buy, Hold or Sell?

I think UPS will continue to do well in the coming years. The U.S. Economy is growing steadily, giving UPS a solid core business. Online shopping will continue to be a growth vector for revenues and as UPS shows the best margins in the industry, it will be able to squeeze its way into more profit. I believe UPS is a buy now investment.

Disclaimer: I do not hold UPS, WMT or TGT in my DividendStocksRock portfolios.

I do own shares of AMZN.

The opinions and the strategies of the author are not intended to ever be a recommendation to buy or sell a security. The strategy the author uses has worked for him and it is for you to decide if it could benefit your financial future. Please remember to do your own research and know your risk tolerance.

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Analyst’s Disclosure: I am/we are long AMZN. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.