If you want a combination of a good dividend yield (in this case, 3.9%) from a leading industry player with great long-term growth prospects, look no further than UPS (UPS 0.02%). Yes, the company faces near-term headwinds, but the market has arguably factored the slowing economy into the stock price. Meanwhile, management's restructuring of the business for growth continues apace, and UPS is highly likely to emerge as a much stronger company coming out of a trough year in 2023. Here's why UPS is an excellent stock for income-seeking investors.
UPS offers income and growth
The following chart helps to explain the key points quantitatively, and then we'll dig into how UPS is improving its underlying growth prospects.
The chart below shows how well UPS's cash dividends have been covered by earnings before interest, taxes, depreciation, and amortization (EBITDA), and free cash flow (FCF). In addition, included are Wall Street analyst consensus estimates for 2023-2025 to indicate a couple of critical points.
First, this year will likely prove a trough year (more on that in a moment), but EBITDA and FCF will easily cover UPS' cash dividends in 2023-2025.
Second, it's worth noting that UPS's FCF soared in 2020-2022. This is partly due to soaring earnings (see EBITDA) and partly due to the dramatic increase in demand for deliveries caused by stay-at-home pandemic measures. It's also due to a drop in capital expenditures (another point I'll get to in a moment) from an average of $6.3 billion in 2018 and 2019 compared to $4.8 billion, which boosts FCF generation. Still, even if you take the five-year average FCF and five-year cash dividends paid (to iron out the capital expenditure fluctuations), the FCF to dividend cover is 1.9 times.
Whichever way you look at it, UPS' dividend is well covered.
Data source: UPS presentations.
Qualitative analysis
As noted, UPS cut its capital expenditures in 2020-2022 compared to 2018-2019. While this is partly due to the natural investment cycle, CEO Carol Tome has also led the company to focus more on sweating its existing assets instead of chasing delivery volume -- the so-called "better, not bigger" strategy.
It's an approach encapsulated by the willingness to reduce Amazon.com-related sales as a share of UPS' business. As CFO Brian Newman said in January, Amazon sales represented 11.3% of UPS' sales in 2022, down from 11.7% in 2021. He said: "We'll continue on a mutually agreed path to glide that business down in 2023."
Data by YCharts
However, UPS wants to expand into crucial targeted markets like small and medium-sized businesses (SMBs) and healthcare. As previously noted, the "better, not bigger" approach and the focus on developing SMB, healthcare, and more profitable international and e-commerce deliveries had led UPS to improve its margin profile through increasing its average revenue per piece, even as volume growth declined.
UPS appears more than willing to accept some volume decline if it's the right sort of low-margin volume decline.
What about 2023?
That said, it's indisputable that the expected volume decline in 2023 is part of the plan. When discussing U.S. domestic volume in the first-quarter earnings report, Newman noted: "We expected average daily volume to decline between 3% and 4%. For the quarter, average daily volume was down 5.4% year-over-year." He also noted that the "revenue quality initiatives" didn't entirely "offset the decrease in volume and as the decline in volume accelerated toward the end of the quarter."
The weakness in the global economy is putting pressure on UPS' volumes, even if the ongoing initiatives with SMBs and healthcare are improving its long-term earnings potential.
A stock to buy for passive income?
I think the answer is "yes." The company faces headwinds in 2023, but its dividend remains well covered and offers a good yield at the current price. Meanwhile, the company's growth initiatives and focus on improving its network ensure ongoing cash flow generation.
History suggests the economy will improve again, and UPS will emerge from a trough period in better shape than when it entered it. Meanwhile, investors can earn a 3.9% yield while they wait for the cycle to turn upward again.
