The package delivery giant is headed in the right direction.
Wall Street liked what it heard when United Parcel Service (UPS -0.67%) announced its third-quarter results last Thursday. UPS stock jumped after the company beat earnings estimates.
But it wasn’t just analysts who had reason to celebrate after the package delivery giant reported its latest quarterly results. UPS also gave good news to income investors who love its 4.7% forward dividend yield.
The primary concern with UPS’ dividend
If a company can’t easily afford to fund its dividend, income investors won’t have a warm and fuzzy feeling about its stock. That has been the primary concern regarding UPS’ dividends.
In 2023, UPS paid out $5.37 billion in dividends. However, the company generated free cash flow of $5.25 billion. That’s an imbalance income investors don’t like to see.
The picture is seemingly getting worse. In UPS’ Q3 earnings call, CFO Brian Dykes said the company plans to pay roughly $5.4 billion in dividends in full-year 2024, subject to the approval of its board of directors. However, he also stated that UPS expects to generate free cash flow of around $5.1 billion in 2024.
UPS’ dividend payments as a percentage of free cash flow projected in full-year 2024 aligns with its earnings-based dividend payout ratio of 106%. The widening gap between how much the company returns to shareholders as dividends and how much it generates in free cash flow isn’t a positive trend.
Reasons to feel more confident
So what is the good news UPS just gave to income investors? Its financials are clearly improving, albeit not enough to change the full-year numbers as much as income investors might like.
Importantly, UPS returned to both revenue and profit growth in Q3. It did so despite what CEO Carol Tomé described in the quarterly earnings call as a “macro environment that was slightly worse than we expected.”
Dykes noted that U.S. volume growth was “the highest growth rate we’ve seen in more than three years.” Domestic volume began gaining strength in the second quarter. However, the quality of the revenue wasn’t as attractive because of an influx of lightweight e-commerce packages. Tomé said that UPS made adjustments to pricing and its operating plans in Q3 to improve the revenue quality.
She specifically mentioned the company’s addition of the USPS Air Cargo business and the sale of Coyote Logistics. Tomé explained that these moves “eliminated a highly volatile truckload brokerage business and added air cargo volume that is predictable and margin positive.”
Dykes also brought up UPS’ cost management initiatives that reduced the cost per piece transported by 4.1% year over year. The company’s operational closures have enabled it to increase pieces per workforce hour by 8%, which Dykes said translates to an efficiency gain of roughly 11 million hours.
Revenue and earnings growth, higher revenue quality, and improved efficiency should help UPS generate higher free cash flow in the future. The increased costs associated with the company’s contract with the Teamsters Union were also heavily front-loaded. UPS’ cost structure, at least in the U.S., should look better over the next four years.
Going for sweet 16?
UPS increased its dividend for the 15th consecutive year in January 2024. Granted, it was only a $0.01 dividend hike, but an increase is an increase. Can income investors expect the company to go for “sweet 16” with another dividend boost next year? I think so.
UPS has resumed its stock buybacks. Dykes confirmed that the company repurchased $500 million of its shares in Q3. If push came to shove, UPS could reduce or suspend the buybacks to ensure it can extend the streak of dividend increases.
More importantly, the outlook for UPS is unmistakably improving. The company isn’t going to turn into a massive growth machine anytime soon, but it shouldn’t have a difficult time funding its dividend. That’s good news for income investors.
