UPS (UPS 0.65%) is having a challenging year, so don't be surprised if there's more volatility to come soon. That said, long-term investors won't worry if the company can deliver long-term growth while maintaining a handsome dividend (current yield is 4.3%). There's a strong case for the latter, and UPS represents one of the most attractive stocks on the market for income-seeking investors. Here's why.
UPS in 2023
First, let's touch on why UPS stock is down 12.6% this year. It comes down to weaker-than-expected volumes in both its U.S. domestic package and international segments. Volumes have declined significantly in 2023, and even though average revenue per piece improved in the U.S. domestic package segment and overall in its package delivery business (UPS also has a supply chain solutions business), it wasn't enough to stop revenue from declining.
|
UPS First Half YOY Growth |
Average Daily Package Volume |
Average Revenue Per Piece |
Revenue |
|---|---|---|---|
|
U.S. Domestic Package |
(7.6)% |
4% |
(3.9)% |
|
International Package |
(6.4)% |
(2.8)% |
(10)% |
|
U.S. domestic and International |
(7.5)% |
2.5% |
(5.4)% |
Data source: UPS presentations. YOY=year over year.
Consequently, management has lowered its full-year revenue and profit guidance as the year has progressed. Moreover, the guidance cuts are significant.
|
Full Year Guidance |
January |
April |
August |
|---|---|---|---|
|
Revenue |
$97 billion to $99.4 billion |
$97 billion |
$93 billion |
|
Adjusted Operating Margin |
12.8%-13.6% |
12.8% |
11.80% |
|
Implied Adjusted Operating Profit |
$13 billion |
$12.4 billion |
$11 billion |
Data source: UPS presentations.
There are three interconnected reasons for the weakening volumes. First, a slowing global economy naturally leads to slowing demand for package deliveries. Second, the lockdowns imposed on populations significantly dislocated the global economy. The travel restrictions and stay-at-home measures boosted demand for physical goods in 2020-2022. However, now that everyone is stocked up on consumer electronics, home goods, and so forth, there's a natural shift back into spending on services such as travel and leisure. That's not good news for a company that benefits from exchanging physical goods.
Third, the supply chain challenges over the last couple of years (caused by the lockdown measures) encouraged many companies to hold excess inventory due to being concerned about potentially running out of supplies. Now that the supply chain issues are easing, companies are running down excess inventory, causing a slowing of demand for the delivery of some physical goods.
Image source: Getty Images.
UPS' best days are ahead
The company faces challenges in 2023, but long-term investors must consider the bigger picture.
- The challenges discussed above are cyclical and likely to prove temporary.
- UPS continues to make structural improvements to its business, which means it will come out of the slowdown as a stronger company.
The first argument above should be self-evident when looking at the reasons for the volume declines. History suggests the economy will return to growth in a more accommodative interest rate environment, and the dislocations to the economy created by the lockdowns will balance out in time.
Structural improvements
The improvements to UPS' business in recent years center around the transformational strategy launched in 2018 and CEO Carol Tome's "better, not bigger" framework. The transformational strategy emphasizes growing its small and medium-sized (SMB) business and healthcare revenue, profitable expansion in e-commerce-related deliveries, and expansion in high-growth international markets.
Meanwhile, the better not bigger framework implies a willingness to forego volume growth to focus on maximizing the profitability of its deliveries and the productivity of its network. This benefit can be seen in the improving revenue per piece (see first table above) and the upward drift in UPS margins in recent years.
UPS Operating Margin (TTM) data by YCharts
As previously discussed, despite the difficulties in 2023, UPS is on track to hit its medium-term SMB and healthcare initiative targets. Of particular note, UPS' SMB-centric digital access program (DAP) related revenue was $1.3 billion in 2021 and is set to hit $3 billion in 2023, while being rolled out internationally. The DAP initiative was well timed as many SMBs aggressively sought to expand their e-commerce capability during the pandemic, and UPS can continue to build on these relationships. Meanwhile, healthcare revenue is set to hit $10 billion in 2023, in line with management's medium-term plans.
A stock to buy
While there's potential for near-term disappointment due to cyclical weakness, UPS is improving its underlying business structurally. If the improvements continue, then it's likely to have a better margin profile coming out of the slowdown. Throw in a handsome dividend while you wait for the cycle to turn, and UPS represents an attractive stock to buy on a dip for long-term investors.
