United Parcel Service (UPS -1.51%) is an economic bellwether that provides a good reading on the economy. That's because people tend to spend more on package deliveries when the economy is good. The same goes for businesses. UPS also operates a sizable international division, as well as supply chain solutions like freight shipping and logistics.
There's no denying UPS' dominant position in the transportation sector. But is it really a good idea to buy the dividend stock leading into a potential prolonged slowdown? Let's find out.
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A period of slowing growth isn't a reason to worry about UPS
Daniel Foelber: Declining consumer spending, rising interest rates, rampant inflation, and the potential for rising unemployment are all reasons to be pessimistic about the prospects of a cyclical company like UPS. And while UPS could very well face difficult comps and even declining earnings in the years to come, that doesn't mean that the stock isn't worth buying now.
UPS CEO Carol Tomé and CFO Brian Newman and their teams have done a masterful job positioning UPS to weather an impending storm by expanding product and service offerings, growing relationships with customers of all sizes, and shoring up the balance sheet. Despite operating income outpacing growth, trailing 12-month capital expenditures are 25% lower today -- a sign that UPS is managing costs while growing the top line.
The company's balance sheet has never been better, as financial metrics and debt levels indicate UPS has been using excess free cash flow to pay down debt and get its financial health in order.
Economic downturns and slowing package delivery volumes are never what UPS investors want to hear. But these periods are simply part of the business cycle. The good news is that UPS is prepared for a downturn. And its pricing power is arguably more "sticky" than other cyclical companies.
Today's economy is heavily dependent on shipping and e-commerce. UPS has been able to combat higher input costs and inflation with price increases. If package delivery volumes slow, UPS may still be able to offset rising costs. And if the economy does enter a downturn, inflation will likely decline too. Lower inflation would coincide with lower labor and fuel costs -- two significant expenses for UPS.
UPS is a package delivery juggernaut with high margins, capital discipline, and industry leadership that is well-positioned to fight inflation with more price increases or benefit from slowing inflation through cost reductions. UPS also has a dividend yielding 3.7% at recent prices, offering a stable source of passive income.
Be wary of near-term challenges
Lee Samaha: On balance, I happen to agree with Daniel that UPS is worth buying. However, it's important to note that there is a near-term bear case for the stock. As such, it should not be purchased by all investors, particularly not by those who can't stomach some potential near-term volatility.
The potentially bad news comes from two related sources. First, it's no secret that UPS faces near-term headwinds from slowing global growth -- its rival FedEx has already reported disappointing results in its most recent quarter to the end of August. Slowing growth means weaker delivery volumes, which causes revenue and profitability challenges.
Second, the uncertain volume outlook (particularly in the business-to-consumer, or B2C, market) creates additional operational challenges during the holiday season. For example, UPS and FedEx have faced issues in previous holiday seasons due to the difficulty of predicting what volumes will be like on peak days.
Since it's not feasible to structure a delivery network to handle peak delivery volumes 365 days a year, UPS and FedEx have to prepare their networks for the surges in volumes that come on specific peak days.
If they overestimate B2C volumes during peak days, they will be left with overcapacity and unnecessary costs. On the other hand, if they underestimate volumes, they are also likely to incur high costs, such as using expensive third-party transportation.
Given the uncertainty in the global economy right now, and in particular, the pressure on consumers, it's harder to predict where B2C volumes will end up this year, and not least, what they will be like during the peak delivery days.
So, don't be surprised if UPS reports signs of B2C volume challenges in the next few months. There's also the potential for disappointment in the holiday season. Of course, a few months of trading shouldn't unduly concern long-term investors in UPS, but cautious investors may want to wait until after the holiday season before buying in.
