The shares of package delivery giant United Parcel Service (UPS 1.33%) have fallen around 25% from recent highs. That massive decline has pushed its yield up to 4%, which is toward the high end of the company's historical yield range. Is this a buying opportunity for income investors or is something really wrong at UPS today?
UPS isn't exactly hitting on all cylinders right now. In fact, first-quarter earnings were a little disappointing, missing analyst estimates. And while management has stuck to its full-year guidance, Wall Street isn't exactly confident that the company can live up to those self-imposed expectations. The problems here, however, are bigger than a single quarter.
For several years, UPS has had difficulty keeping up with demand during the peak holiday season. It has been spending heavily to upgrade its system to cope with the huge influx of deliveries driven by online shopping. During the first-quarter 2019 conference call, management was clear to point out that the current year will be another one of heavy spending. That's putting a crimp on the company's cash flow. With no clear end in sight for this spending (or dramatic improvements in holiday season performance), investors are growing impatient.
Adding to the concern is that Amazon (AMZN 3.04%) is building its own shipping network. Put simply, UPS and its key peers will increasingly compete with a well-heeled competitor -- one that, at times, doesn't seem to worry about profits as it seeks out new avenues of growth. In fact, in an extreme case, Amazon could simply look at package delivery as a customer benefit and be content with break-even results (or even a slight loss). That wouldn't be OK for publicly traded UPS.
So there are very real issues facing UPS today. But the outlook isn't as bad as it seems when you dig in a little bit deeper. And that makes the historically high-dividend yield today look particularly attractive for investors willing to think long term.
The positives add up
Taking the Amazon threat first, UPS notes in its annual report that "no single customer accounts for 10% or more of our consolidated revenue. We do not believe the loss of any single customer would materially impair our overall financial condition or results of operations." In other words, Amazon is an issue to watch, but it probably isn't as big a deal as the headlines suggest. There are many major online retailers that use UPS, and that's unlikely to change. In fact, despite the weak financial results in the first quarter, average daily U.S. air freight volume was up 8%, year over year, and international volume advanced 12%. There's clearly still strong demand for UPS' services, and that demand is likely to increase along with the growth of online shopping.
The elevated spending that's been taking place is harder to accept, since there's seemingly no end in sight to the cost of upgrading UPS' systems. But try to look at this another way: It's more a symptom of the strong demand than a negative about the UPS service. It costs money to grow a business, and UPS is clearly seeing the demand there to justify spending the money and time to expand. Yes, the cost is hitting the company's financial results today, but for those with a long-term view, this transition period will eventually pass.
The next positive here is valuation. The yield is high today, but price to revenue, price to earnings, price to cash flow, and price to book value are all below their five-year averages -- in some cases by a notable amount. It looks like Wall Street has put the stock in the discount bin, despite the fact that its underlying operations remain in high demand and that it is working hard to improve its competitive position.
Worth a deep dive
For investors who can stomach a little near-term turbulence, out-of-favor UPS is worth a close look. That's particularly true if you are an income investor, noting the stock's hefty 4% yield. The only thing that might keep an investor on the sidelines is the company's balance sheet, where debt sits at roughly 85% of UPS' capital. That might be a little too high for conservative types and shows that UPS is not a set-it-and-forget-it investment. But if you are willing to keep an eye on the company's debt load and operational progress, that shouldn't stop you from adding UPS to your portfolio.