United Parcel Service (UPS 0.14%) and Texas Pacific Land (TPL 0.62%) have moved in dramatically different directions over the last three months, with the former down 10% and the latter rising a blistering 41%. While UPS would be hard-pressed to have more things working against it, Texas Pacific continues to generate near-record free cash flow (FCF), with rising oil prices set to potentially increase these figures.
Despite this divergence in recent share price performance and short-term business outlook, I cannot wait to add to these dividend growth stocks in October. Whether it is UPS' 4.1% dividend or Texas Pacific's nearly annual special dividends, these two businesses could set me up for a lifetime of rising passive income potential.
UPS is at a once-in-a-decade valuation
Avoiding a massive potential strike in July, United Parcel Service and the International Brotherhood of Teamsters reached a five-year deal that covered over 330,000 of its employees. While it's not unreasonable to think UPS' contract settlement could be a temporary headwind for the stock, I'll never fault a company for paying its employees better -- particularly when it's not egregious stock-based compensation for executives.
Now that this deal is in place, the company can turn its focus back to the sales it lost from customers choosing other shipping options amid fears of an ensuing strike disrupting their deliveries. Due to this disruption (along with general consumer spending softness), the U.S. average daily volume (ADV) dropped 10% in the second quarter. Making matters worse, international sales struggled more than expected, causing UPS to post revenue and earnings-per-share (EPS) declines of 11% and 23%, respectively.
So why on Earth am I excited to buy UPS in October?
First, the company's automation processes are continuing to build momentum. For volume initiated in the U.S., 57% of goods went through an automated hub -- up from 53% last year. While this increase may seem diminutive, each percentage point of improvement will pay significant dividends, especially considering the company's increasing labor costs.
Second, UPS recently acquired another healthcare logistics company, MNX, bolstering its rapidly growing healthcare unit expected to record $10 billion of sales in 2023 -- or roughly 10% of total revenue. Industry research firm Market Research Future projects the healthcare logistics industry will double by 2032 to $179 billion in sales, highlighting a significant opportunity for the company's burgeoning healthcare unit.
Furthermore, UPS is now operating in 49 of the largest cities in India, thanks to its MOVIN business -- a joint venture with InterGlobe Enterprises that provides business-to-business shipping in the country. Statista expects India's gross domestic product (GDP) to grow by 6% annually through 2028, making the world's fifth-largest economy (by GDP) a massive opportunity for UPS.
The cherry on top of it all for investors? UPS stock is trading at just 8.5 times earnings before interest, taxes, depreciation, and amortization (EBITDA), barely above its 10-year low.
UPS EV to EBITDA data by YCharts. EV = enterprise value. EBITDA = earnings before interest, taxes, depreciation, and amortization.
Thanks to this depressed valuation, the company's 4.1% dividend yield is the highest it has been over the last decade, except for the 2020 crash. Using only 55% of its net income to deliver average dividend increases of 12% over the previous five years, UPS looks like a great bellwether dividend grower to buy in October at today's significant discount and hold through short-term issues.
Texas Pacific Land: A clear beneficiary of $100 oil
Texas Pacific Land owns 886,000 acres of land in West Texas, most of which reside in the oil-rich Permian Basin. Leveraging its incredible geographic footprint -- which is the result of the Texas and Pacific Railway bankruptcy -- Texas Pacific generates revenue from oil and gas royalties, water sales, and SLEM (easements and surface-related income).
Although the company is not an oil and gas producer, it is directly tied to the industry since its customers lease Texas Pacific's land to build oil and gas wells, paying royalties on what they produce. In addition to these royalties, the vast majority of these oil and gas producers use water produced on the company's land to be able to drill wells and start production.
Capping things off, this oil and gas is pumped through pipelines on the company's land, giving it one final revenue stream, thanks to the easements (a right to cross or otherwise use someone else's land for a specified purpose) it has in place for its land.
As wildly unexciting as these operations may seem, this operating model is incredibly asset-light and generates mountains of FCF. While the company has quadrupled FCF in just the last five years, its stock has more than doubled over the same time.
Although this FCF generation alone is impressive, the company's future may be even brighter. Management estimates it has only developed roughly 14% of its total royalty acreage, leaving a tremendous growth runway for future wells. Furthermore, they believe there is about 14 years of oil inventory at a breakeven price of $40 per barrel. With oil prices hovering around the $100 per barrel mark again, production and new drilling should continue to be stronger than ever, extending the company's recent quarters of new all-time highs in FCF.
Most importantly for investors, however, is that Texas Pacific gives virtually all of this FCF back to investors. Over the last decade, the company has lowered its shares outstanding by about 1% annually while raising its regular dividend payments by 5,100% over the same time. With Goldman Sachs increasing its 2024 oil forecast to $100, I'll happily keep buying Texas Pacific and its combination of low breakeven oil prices and massive drilling growth runway -- even at a slightly lofty 33 times FCF.
