After a record 2020, United Parcel Service (UPS -0.51%) is showing no signs of slowing down. Shares of UPS have nearly doubled over the last three years and are up 23% year to date.
The stock is now hovering around an all-time high, but there are good arguments that it's still cheap given the long-term investment thesis. Here are five reasons UPS stock should keep going up from here.
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1. It's navigating supply chain and labor issues well
In 2020, UPS was one of the few industrial companies to post record top- and bottom-line results. This year, it is one of the few industrial companies with a handle on its supply chain, as well as its labor force, despite rising costs.
UPS has one of the most complicated supply chains imaginable. It's responsible for delivering packages on time to residential, commercial, and industrial customers around the world. Yet because of planning and a good management team, it has retained its double-digit operating margin and even forecasts its adjusted operating margin will be 13% in the fourth quarter. Retaining a high operating margin shows that the company is successfully converting revenue to profit and managing costs in a way that limits the impact on its bottom line.
2. It's delivering record results
In fact, UPS delivered record third-quarter 2021 revenue of $23.2 billion, up 9.2% over its record prior-year quarter. It also generated diluted earnings per share (EPS) of $2.65 for the third quarter, 18.9% above the year-ago period. The company is generating more free cash flow (FCF) than ever before, which is allowing it to grow its dividend, pay down debt, reinvest in the business, and buy back stock.
For reference, consider that UPS generated $9.3 billion in FCF in the first nine months of 2021, which was nearly four times the $2.58 billion it paid in dividends. Many companies don't generate enough FCF to cover their dividend, much less easily cover it by a factor of two or more.
3. The optimistic Q4 outlook
The package delivery business is seasonal, and no season demands more from UPS than the fourth quarter. Headed into the holiday season, the company is firing on all cylinders and could post its best quarter in company history.
However, UPS is preparing for what it sees as a unique holiday season filled with both premature buying and delayed buying. Early birds may order ahead of time to account for supply chain bottlenecks. And a high number of gift cards would lead to more holiday-related deliveries into January. UPS can't control container ships jammed up at ports. But it can control its supply chains once it can transfer those items onto its trucks.
4. Its long-term growth catalysts
Arguably more important than how UPS is doing today is how it's going to perform one, three, five, or even 10 years into the future. What makes UPS such a good business is that all three of its segments (U.S. domestic, international, and freight) continue to grow while operating at high profit margins. Driving that growth is an increasingly intertwined global economy, but also trends such as e-commerce, healthcare, and automotive shipping services.
Starting in late 2019, UPS made it its mission to improve its services for small and medium-size businesses (SMBs). The strategy was simple: If UPS could be the shipper of choice for SMBs, then it would become an integral e-commerce player as more and more small retailers turn to online sales. The pandemic accelerated the adoption of the UPS Digital Access Program, which is basically its suite of logistics, shipping, and payment services for businesses.
In the third quarter, SMBs made up over a fourth of the company's U.S. package delivery volume. SMBs also include smaller healthcare customers that can use services like UPS Premier, which focuses on expedited shipping for time-critical medical products. The shipper's investments in its healthcare business are the main reason it has delivered over 1 billion doses of COVID-19 vaccines.
5. Its sizeable and growing dividend
As mentioned, strong earnings and FCF support a stable and growing dividend. UPS pays $1.02 per share per quarter, double what it paid in 2010 and 5 times what it paid 20 years ago. With an annual yield of 2%, the dividend provides the cherry on top of an already solid company. And because the business should continue to grow well into the future, it stands to reason the company will keep increasing its dividend.
The complete package
The ability of UPS to perform no matter the business environment is a testament to its market-leading position, which it shows no signs of losing anytime soon. The package delivery industry is capital intensive, requires many employees, is logistically challenging, and is incredibly hard to compete in. New players don't come around often.
FedEx's (FDX -0.59%) earnings miss quantified just how big a toll that cracks in the real economy were taking on its business. It also differentiates FedEx from UPS and shows that UPS is better suited to handle crises. But both companies are raising prices in 2022 by 5.9% or more to offset inflation and higher labor costs.
In sum, UPS deserves to be at an all-time high because its business performed well during the pandemic, continues to perform well despite economic challenges, and is positioned to perform well for years to come.
