United Parcel Service (UPS 0.09%) is often seen as an economic bellwether, and for good reason. The package delivery, shipping, and logistics provider is a global titan that provides a good reading on the health of the consumer, the e-commerce industry, and businesses as measured by freight volumes. Based on its latest guidance, things look cautiously optimistic.
UPS continues to separate itself from its peers by offering superior services that command a premium price. Here's why UPS stock is worth buying now.
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UPS just had an impeccable quarter
UPS' third quarter had just about everything investors could have hoped for. Strong margins, a little bit of growth even relative to a red-hot Q3 2021, and the confidence that UPS is on track to meet its 2022 goals.
The biggest highlight from the quarter was that UPS reaffirmed its full-year 2022 guidance for record revenue of $102 billion, an operating margin of 13.7%, and return on invested capital (ROIC) above 30%. For context, if UPS hits its goals it would mark a 10-year high operating margin and close to a 10-year high in ROIC.
Meeting expectations during an uncertain time illustrates UPS' accurate forecasting, as well as its ability to operate a high-margin business and pass along inflation-related costs to its customers.
NYSE: UPS
Key Data Points
Diving into UPS' high margins
On its Q3 earnings call, UPS indicated some weakness in its international business. International earnings were negatively impacted by a strong U.S. dollar, which dilutes revenue made overseas. Given these headwinds, it's all the more impressive that UPS is still on track to produce its highest annual operating margin in a decade.
UPS attributed its strong operating margin to its ability to raise prices to offset headwinds such as high fuel and labor costs, other inflation-related costs, and the strong U.S. dollar. UPS' superior profitability is no accident. Over the last few years, it has expanded routes and improved the quality of its services to residential customers and businesses. Small and medium-sized businesses now make up 28.3% of total U.S. volume. And it expects to generate $10 billion in healthcare revenue by 2023. UPS also said that it led its peers in quality of service during the last four holiday (peak) seasons, which justifies its price increases.
Staying disciplined
Despite its strong guidance for 2022, UPS could be in for a challenging time in 2023, both in terms of comps and if package delivery volumes decline. While UPS can't control the economic cycle, it can control the steps it takes to navigate a downturn.
A good way to gauge a company's attitude toward challenges is to listen to the earnings call and see how management responds to questions that are similar to the ones you have as an investor. For me, I want to make sure that UPS doesn't over-hire during the peak season this holiday quarter in case consumer spending is lower, and make sure it isn't planning to ramp capital expenditures or over-expand and then have to cut costs. After all, it's far easier for a company to scale up during a downturn than cut back.
Arguably the most important portion of the UPS Q3 earnings call was how CEO Carol Tome responded to an analyst question regarding the company's expectations heading into 2023. Carol Tomé said the following:
Well, maybe I'll start with just a philosophical approach to building a plan for '23. ... So first, this is a very interesting time to be building a financial plan because there is so much uncertainty. There's economic uncertainty, there is geopolitical uncertainty. We do have a contract that's coming up for renewal next year as well. So there's a lot of uncertainty, but here's our philosophical approach to building the plan. One, we're going to stay on strategy because we believe that we should invest through whatever comes our way, so that we can continue to improve the customer experience, as well as the employee experience. So we're going to stay on strategy. We're going to build more agility into our plan than we've seen before, and I would say we're pretty agile today. Well, we're going to -- we have to be able to turn on a dime, and so we're going to build agility into the plan. We're going to build a plan of conservatism because if you're too optimistic, then your expenses are too high and then there's a whole bunch of wood you have to chop to get those expenses out. So we'll plan conservatively, and we'll factor into the plan some of the challenges that will come our way as a result of higher interest rates and what that may mean to our pension.
In sum, UPS is taking a cautiously optimistic approach to 2023. It's worth noting that UPS kept a tight lid on capital expenditures in 2021 and 2022 despite a strong 2020. So the company has a track record for not over-expanding, even when it has the means to do so.
A dividend backed by ample free cash flow
An even-keeled spending plan supports strong free cash flow and a high-quality dividend. Earlier this year, UPS raised its dividend by 49%. The stock currently yields 3.7%, which is far above the S&P 500 dividend yield of 1.8%.
UPS' free cash flow for the first three quarters of 2022 was $8.5 billion, which was more than double the $3.8 billion it paid in dividends. And that includes the massive dividend raise earlier in the year.
A reliable long-term buy
UPS stock is a worthwhile investment because the company has a track record of capturing upside and effectively managing whatever challenges come its way. UPS is best in breed in terms of its management team, the company's efficiency, and its unparalleled resources. And the stock's 3.7% dividend yield is a sizable source of passive income -- adding a cherry on top of a fundamentally strong business.
