Share prices of United Parcel Service (UPS 1.58%) slid over 10% last week due to fears of slowing growth. While it's true that the transportation company is facing delivery volumes challenges, its top and bottom line don't seem phased.
At the end of the day, UPS's success isn't about the number of packages it delivers. It's about the revenue it generates, the profit margins it can get from that revenue, spending capital efficiently to grow the business, and generating consistently strong free cash flow (FCF). Its first-half results prove that the company is doing all of those things quite well. Here's a breakdown of why UPS is a great dividend stock to buy now, even if the market crashes.
Image source: Getty Images.
UPS is keeping the free cash flowing
In the first half of 2021, UPS generated more FCF than any full year in company history -- which is pretty incredible considering how well it has performed over the last few years. So how did it do it? Well, there were no magic tricks. No confusing accounting adjustments. It's just good business, helped by lower spending.
|
Metric |
Six Months Ended |
12 Months Ended |
|---|---|---|
|
Cash Flow From Operating Activities |
$8,454 million |
$10,459 million |
|
Capital Expenditures |
($1,670 million) |
($5,412 million) |
|
Other Items* |
$20 million |
$43 million |
|
Free Cash Flow |
$6,804 million |
$5,090 million |
*Other items include proceeds from disposals of plant, property, and equipment (PP&E), net change in finance receivables, and other investing activities. Data source: UPS.
CEO Carol Tomé attributed strong FCF to the company's "disciplined approach to capital allocation." She has a point. UPS is guiding for 2021 return on invested capital (ROIC) of 28%, which would be the highest annual ROIC in five years. Unlike 2020, which was more focused on expanding UPS's residential and small-and-medium-sized customer base, this year is about capitalizing on a product and service offering that has taken years to build.
Why do cash cows make great dividend stocks?
UPS uses FCF to pay dividends, buy back shares, and pay down debt. Generating high amounts of FCF shows the business is performing well enough to do things outside of its normal operations and makes it less susceptible to downturns. It also frees up dry powder in case a nice investment or acquisition candidate comes around. In short, a healthy balance sheet positions the company to navigate volatility and take advantage of opportunities.
More dividend raises look likely for UPS
In the first half of the year, UPS completed its full-year goal of paying down $2.55 billion in long-term debt. It also paid $1.7 billion in dividends and generated $5.12 billion in adjusted non-GAAP net income. Net income would have been even higher if it weren't for UPS's large pension obligation, which directly impacts its bottom line.
In the beginning of 2021, UPS instituted a new dividend payout target of roughly 50% of its net income. In the first half of 2021, it distributed roughly one-third of its net income -- or one-fourth of its FCF -- to shareholders through dividends. Given the disparity between its intended and actual payout ratios, there's a good chance UPS will raise its dividend again next year. In the meantime, the company reaffirmed its plan to spend just $4 billion on capital expenditures -- 27% less than last year.
Although there are currently no plans to buy back shares, the company called out the strength of its FCF and reduced pension liabilities as two reasons why it could consider buying back shares in the second half of the year. In February, UPS increased its quarterly dividend to $1.02 per share per quarter, giving it an annual yield of 2.1% at the time of this writing.
A dividend built to last
No one knows when the next market sell-off will come. But just like with the March 2020 plunge, it's easier to ride out a downturn if you own companies with strong fundamentals and bright long-term futures. Tomé's background as CFO of Home Depot has benefited UPS -- UPS is leaner and more efficient than ever before. Management did a good job tapping into higher residential demand during the pandemic, and it is doing an equally impressive job driving profitability so far this year.
Given its strong FCF and improving balance sheet, UPS stock looks to be a long-term winner that can outlast a market crash.
