United Parcel Service: Continues To Deliver The Goods, Now Show Me The Dividend Growth
Summary
- United Parcel Service is a Dividend Contender with a 12-year streak of annual dividend growth. Shares currently yield 1.90%.
- United Parcel Service is poised to benefit from the supply chain disruptions seen since early 2020 and further growth in global package delivery.
- United Parcel Service is poised to deliver solid returns for investors.
Alex Wong/Getty Images News
As we all learned over the last few years, home delivery of goods is critical and has been taking more share over traditional in-store purchasing. Spurred by the lockdowns and a fear of the unknown surrounding the pandemic, United Parcel Service (NYSE:UPS) proved just how critical the business is to global commerce.
UPS operates in three segments: Domestic package delivery, International package delivery, and supply chain solutions.
Source: Author; Data Source: United Parcel Services SEC filings
The TTM period shows impressive growth compared to FY 2020 of 9.1%, 18.6%, and 12.8% across each segment resulting in 11.6% overall growth. Considering that doesn't include the expected growth from 4Q 2021 in the numbers, that's quite impressive.
Dividend History
As a dividend growth investor, I aim to invest my savings into businesses that generate more cash flow through their operations that they can then send out to me in the form of dividends. The strategy just appealed to me because dividends, assuming the business is picked right, are more consistent on a year-to-year basis and easier to predict than the sentiment of the market over a short period of time.
Source: Author; Data Source: United Parcel Service Investor Relations
UPS has raised their annual dividend payout for 12 consecutive years. Their streak actually began in 1999, but came to an end in 2009 as dividends were frozen. Considering all that was going on in the financial world at that time, that's definitely excusable.
Dating back to 1999, UPS' year-over-year dividend growth has ranged from 0.0% to 126.7%, with an average of 14.4% and a median of 8.9%.
Over that same time, there have been 18 rolling 5-year periods with annualized dividend growth ranging from 5.5% to 30.1%, with an average of 10.5% and a median of 8.1%.
There's also been 13 rolling 10-year periods with UPS' annualized dividend growth ranging from 7.0% to 19.6%, with an average of 9.6% and a median of 8.3%.
The rolling 1-, 3-, 5- and 10-year period annualized dividend growth rates since 1999 can be found in the following table.
| Year | Annual Dividend | 1 Year | 3 Year | 5 Year | 10 Year |
| 1999 | $0.300 | ||||
| 2000 | $0.680 | 126.67% | |||
| 2001 | $0.760 | 11.76% | |||
| 2002 | $0.760 | 0.00% | 36.32% | ||
| 2003 | $0.920 | 21.05% | 10.60% | ||
| 2004 | $1.120 | 21.74% | 13.80% | 30.14% | |
| 2005 | $1.320 | 17.86% | 20.20% | 14.19% | |
| 2006 | $1.520 | 15.15% | 18.22% | 14.87% | |
| 2007 | $1.680 | 10.53% | 14.47% | 17.19% | |
| 2008 | $1.800 | 7.14% | 10.89% | 14.37% | |
| 2009 | $1.800 | 0.00% | 5.80% | 9.95% | 19.62% |
| 2010 | $1.880 | 4.44% | 3.82% | 7.33% | 10.70% |
| 2011 | $2.080 | 10.64% | 4.94% | 6.47% | 10.59% |
| 2012 | $2.280 | 9.62% | 8.20% | 6.30% | 11.61% |
| 2013 | $2.480 | 8.77% | 9.67% | 6.62% | 10.42% |
| 2014 | $2.680 | 8.06% | 8.82% | 8.29% | 9.12% |
| 2015 | $2.920 | 8.96% | 8.60% | 9.21% | 8.26% |
| 2016 | $3.120 | 6.85% | 7.95% | 8.45% | 7.46% |
| 2017 | $3.320 | 6.41% | 7.40% | 7.81% | 7.05% |
| 2018 | $3.640 | 9.64% | 7.62% | 7.98% | 7.30% |
| 2019 | $3.840 | 5.49% | 7.17% | 7.46% | 7.87% |
| 2020 | $4.040 | 5.21% | 6.76% | 6.71% | 7.95% |
| 2021 | $4.080 | 0.99% | 3.88% | 5.51% | 6.97% |
Source: Author; Data Source: United Parcel Service Investor Relations
As a dividend growth investor, I want to make sure that the dividend is well covered by profits and cash flow so the dividend isn't at risk of being reduced should the company stumble for a few years. All else being equal, a lower payout ratio is better as there's also the possibility for dividend growth to exceed growth in the underlying fundamentals.
Source: Author; Data Source: United Parcel Services SEC filings
UPS' payout ratio has fluctuated a lot over the last decade. The 10-year average net income payout ratio is 102% with a 5-year average of 104%. Excluding FY 2012 and FY 2020 that saw unusually low net income levels and the averages drop to 63% and 67%, respectively. Similarly, I've excluded FY 2017 and FY 2019's free cash flow payout ratios which result in 10-year and 5-year averages of 54% and 62%, respectively.
Quantitative Quality
When investing for the long-term the important thing is to focus on the business and let the dividends and capital gains take care of themselves because it's the business fundamentals that will ultimately drive increased value. I like to take a historic perspective to see how the business has performed over time across a variety of financial metrics to see how it got to where it is now.
Source: Author; Data Source: United Parcel Services SEC filings
UPS has grown revenues by 59.4% over the last decade or 5.3% annualized. Gross profits lagged well behind sales growth, climbing just 27.1% in total or 2.7% annualized although the TTM period is showing a solid rebound on that front.
Operating profits tracked along with gross profits rising 26.4% in total or 2.6% annualized while operating cash flow rose 47.9% or 4.4% annualized. Through FY 2020, free cash flow showed a 0.4% total decline compared to FY 2011 although the TTM period is showing a marked increase of 61.3% compared to FY 2011.
The rolling 5-year period CAGRs for UPS' revenue, gross, and operating profits, and operating and free cash flow can be found in the following chart.
Source: Author; Data Source: United Parcel Services SEC filings
Margins are largely set by the specific industry that a business operates. I wouldn't expect a capital-intensive business to carry the same margin structure as a capital-light software business. My expectation is that good businesses will be able to show at least stable, and preferably rising, margins over time.
Source: Author; Data Source: United Parcel Services SEC filings
UPS has shown relatively stable free cash flow margins over the last decade with margins regularly in the mid- to upper-single-digit range. That's lower than I'd like as I usually target at least 10% levels; however, it's still quite strong. The 10-year average free cash flow margin for UPS is 6.1% although the 5-year average is just 3.6% due to FY 2017. Excluding FY 2017 increases, the average of the last 4 fiscal years to 5.9%.
My preferred profitability metric is the free cash flow return on invested capital, FCF ROIC. The FCF ROIC represents the amount of potentially distributable cash flow the business is generating compared to the capital invested in the business.
Source: Author; Data Source: United Parcel Services SEC filings
UPS has routinely been able to generate FCF ROICs in the mid-teens although the trend has been down over the last decade. The 10-year average FCF ROIC for UPS is 19.9% with the 5-year average at 11.2%.
To understand how UPS has used its free cash flow, I calculate three variations of the metric, defined below:
- Free Cash Flow, FCF: Operating cash flow less capital expenditures
- Free Cash Flow after Dividend, FCFaD: FCF less total cash dividend payments
- Free Cash Flow after Dividend and Buybacks, FCFaDB: FCFaD less net cash spent on share repurchases
Source: Author; Data Source: United Parcel Services SEC filings
Over the last decade, UPS has generated a cumulative $37.3 B in FCF, of which they've sent $26.3 B back to owners via dividends. That puts the 10-year cumulative FCFaD at a healthy $11.0 B. UPS has also used a net $17.4 B on share repurchases, which has the cumulative FCFaDB at -$6.4 B.
When done correctly, share repurchases can be a great way to return additional cash to shareholders.
Source: Author; Data Source: United Parcel Services SEC filings
Due to the share buybacks, UPS' share count has fallen from 991 M in FY 2011 to 871 M for FY 2020. In total, the share count has declined 12.1% or 1.4% annualized.
Share repurchases have also slowed significantly and between FY 2018 and FY 2020, the share count has essentially remained flat.
With an eye towards owning stakes in a business for the long term, I want to make sure the balance sheet is in acceptable shape. The first thing I check out is the capital structure by analyzing the debt-to-capitalization ratio.
Source: Author; Data Source: United Parcel Services SEC filings
UPS has typically been heavily financed by debt within their capital structure. UPS' 10-year average debt-to-capitalization ratio is 83% with a 5-year average of 94%.
The net debt ratios give a better idea of how risky the debt levels are in relation to some form of income or cash flow. The net debt ratios let you know how many years of the business' profits would be required to pay off the debt load or in other words roughly how quick the business could de-lever the balance sheet should the interest rate environment change.
Source: Author; Data Source: United Parcel Services SEC filings
UPS' 10-year average net debt-to-EBITDA, net debt-to-operating income, and net debt-to-free cash flow ratios are 1.4x, 2.1x, and 2.3x, respectively. The corresponding 5-year averages are 1.9x, 2.6x, and 3.0x.
While the debt levels of UPS have risen over time, the debt ratios are still within reason compared to the underlying business. UPS also maintains investment grade ratings from Moody's and S&P Global.
Valuation
Valuing a potential investment is tricky, and as such, I use multiple methods in order to try to hone in on a range of what would be attractive levels to purchase shares. The methods that I use are the minimum acceptable rate of return, MARR, analysis, dividend yield theory, and a reverse discounted cash flow analysis.
A MARR analysis requires you to estimate the future earnings and dividends that a business will generate. You then apply a reasonable expected "exit" multiple to determine the future market value of the business. If the expected return is greater than your minimum return target, then you can feel free to invest in the business.
Analysts expect UPS to have FY 2021 EPS of $11.59 and FY 2022 EPS of $12.10. They also expect UPS to be able to deliver 9.75% annual EPS growth over the next 5 years. I then assumed that UPS would be able to grow EPS at a 4.0% annual rate for the following 5 years. Dividends are assumed to target a 37.5% net income payout ratio.
Across the last decade, UPS has typically been valued between ~15x and ~30x TTM EPS. For the MARR analysis terminal multiples, I'll examine exit multiples spanning that range.
The following table shows the potential internal rates of return that an investment in UPS could generate provided the assumptions laid out above are reasonable forecasts of how the future plays out. Returns assume dividends are taken in cash and that shares are purchased at $214.34, Friday's closing price.
| IRR | ||
| P/E Level | 5 Year | 10 Year |
| 30 | 20.4% | 12.9% |
| 25 | 16.3% | 11.0% |
| 22.5 | 14.0% | 10.0% |
| 20 | 11.4% | 8.8% |
| 17.5 | 8.6% | 7.5% |
| 15 | 5.5% | 6.1% |
Source: Author
Additionally, I use the MARR analysis framework to determine what price I could pay today in order to generate the returns that I desire from my investments. My base hurdle rate is a 10% IRR and for UPS, I'll also examine 8% and 12% required returns.
| Purchase Price Targets | ||||||
| 10% Return Target | 12% Return Target | 8% Return Target | ||||
| P/E Level | 5 Year | 10 Year | 5 Year | 10 Year | 5 Year | 10 Year |
| 30 | $336 | $276 | $308 | $234 | $366 | $327 |
| 25 | $283 | $237 | $260 | $201 | $309 | $279 |
| 22.5 | $257 | $217 | $236 | $185 | $280 | $256 |
| 20 | $231 | $197 | $212 | $168 | $251 | $232 |
| 17.5 | $205 | $177 | $188 | $152 | $223 | $208 |
| 15 | $179 | $158 | $164 | $135 | $194 | $184 |
Source: Author
Dividend yield theory is a valuation method built on reversion to the mean and assumes that market participants will value a business such that over time it will provide a relatively constant dividend yield. For UPS, I will use the 3-year average forward dividend yield as a proxy for the fair value price of shares.
Source: Author; Data Source: United Parcel Services Investor Relations and Yahoo Finance
UPS currently offers a forward dividend yield of 1.90% compared to the 3-year average forward dividend yield of 2.97%.
A reverse discounted cash flow analysis can be used to figure out what the current valuation implies about market participants' collective expectation for the revenue growth, margins, and ultimately, the cash flows the business will be able to produce.
The reverse DCF model is built on a tax rate assumption of 22%, a 4.0% terminal growth rate, and an initial free cash flow margin of 8.7% that improves to 10.0% across the forecast period.
Under those assumptions, UPS needs to grow revenues 5.7% annually in order to generate 8% returns. Increasing the discount rate or required return to 10.0% increases the required revenue growth to 11.9% annually across the forecast period.
Conclusion
UPS is a good business that's continued to capitalize on the growing trend of global commerce and fast delivery of goods. UPS was positioned well to improve its business as demand grew in reaction to the pandemic.
Over the last decade, UPS' revenue growth is adequate at 5.3% annualized; however, the majority of those increases were backloaded with growth since FY 2016 coming in at 8.6% annualized through the end of FY 2020. UPS' free cash flow generation does leave a lot to be desired; however, the TTM period is showing a considerable uptick which management expects to carry over. UPS' free cash flow margin for the TTM period is at 8.7% compared to FY 2020's 6.0% mark.
Dividend yield theory suggests a fair value range between $125 and $153, which is significantly below the current share price near $214. UPS is due for a dividend increase that should be announced in February, and using my expectation for a raise to $1.10 per share per quarter, the fair value range increases to $135 to $165, which is still well below the current market price.
The MARR analysis suggests a more palatable valuation for UPS. Based on a 10% IRR and an exit multiple between 17.5x and 22.5x, UPS' fair value range is $205 to $257, putting the current price of $214 on the lower end of the fair value range. Increasing the return target to 12% reduces the fair value range to $188 to $236; however, lowering the return target to 8% increases the fair value range to between $223 and $280.
The reverse DCF seems to imply that 8% returns are more than achievable, but 10% are within reach.
UPS appears attractively valued at current price levels with both the MARR analysis and reverse DCF justifying sold returns. Dividend yield theory does suggest that shares are significantly overvalued based on a return to roughly a 3.00% average dividend yield. If UPS is able to continue to deliver with high-single-digit to low-double-digit growth, then a lower initial dividend yield would be more than justified.
I would be interested in adding to my position in UPS around current levels and will likely do so in the coming week.
This article was written by
Analyst’s Disclosure: I/we have a beneficial long position in the shares of UPS either through stock ownership, options, or other derivatives. 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.
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.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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Comments (17)
215@2.75 yield would give us 1.48 a share / per qt
215@2.5 yield would give us 1.34 a share per qt
215@2.1 yield would give us 1.12 a share per qt
215@1.9 yield gives us our current 1.02 per share
Carol has gotten herself into a tricky situation with her dividend statement,
the Board always releases the new dividend at there early Feb
meeting-so as they say, time will tell
any guess?
would love to see a 2.5 percent yield
4.08 to 4.40
I'll take that
This might be the best peak eve...in a long time.
I'm thinking 1.12 per qt
It is a highly competitive business. Shippers such as Amazon are given vastly reduced rates. Competition, there is Fedex and even the US Postal system.
Amazon also now does their own deliveries, choosing the most profitable, least costly places to deliver. Add to that increased cost for labor, fuel even tires trucks and for UPS planes. I hold both UPS and Fedex. Too many people, including me, tend to think business will go back to what it was. It will not.
watch out for that 2,000lb buffalo in the road ahead as you barrel towards it doing 75 mph looking into that rear view mirror.
