United Parcel Service (UPS -1.20%), usually called by its ticker UPS, is a fairly simple company to understand from a top-level view. But when you dig into the actual business, it is a massively complex operation. Management is trying to make that operation better, which is putting some near-term pressure on the company's financial results.
In time, that headwind should turn into a tailwind. Let's see what this could all mean for investors.
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The UPS backstory
The big story around UPS right now is that it is a fairly low-risk turnaround stock. The 7.7% dividend yield, however, makes the company look like a dividend stock. The problem is that the trailing 12-month dividend payout ratio is up over 95% right now, so it wouldn't be shocking to see a dividend cut. That's doubly true because of what is happening at the business.
A little history is required here. Consumers were stuck at home during the COVID-19 pandemic. They didn't stop shopping, they just bought more from online retailers. That led to a surge in demand for the type of shipping services that UPS provides. Investors pushed UPS' stock higher, extrapolating the temporary demand boost as if it were a permanent one. When the world learned to live with COVID, UPS' shares plunged.
UPS management decided that, with the uncertainty of COVID largely over, it was time to revamp the business for the future. There have been a lot of moving parts, including inking a new (and costly) deal with the union, selling assets, upgrading technology, and closing locations. The big goal is to get more efficient and to focus on the company's most profitable businesses.
The most recent example here is a decision by UPS to pre-emptively cut its relationship with Amazon by 50%. Amazon is a major customer but its business is very low margin.
Turnarounds take time
The problem here is that Wall Street tends to think short-term and UPS is thinking long-term. Simply put, the costs of this overhaul are making the package delivery giant's results look terrible right now. And the upfront costs have helped to push the dividend payout ratio up over 95%. Given that the company is basically resetting the business, it wouldn't be shocking to see the board of directors also reset the dividend to a lower level.
That's why it is better to view UPS as a turnaround stock. But the turnaround risk is fairly low. As long as people live in different places, there will always be a need for package delivery. And it would be very hard to replicate the massive network of UPS employees, trucks, airplanes, and sorting facilities. Even Amazon still uses UPS despite having built a large delivery service of its own. The chances are that UPS succeeds in its overhaul.
But it isn't going to be an overnight success. You need a contrarian mindset here and a long time horizon. There are signs of progress, however. For example, revenue per piece in the company's U.S. business increased 5.5%. Overall revenue was slightly lower due to volume declines, but the business showed profitability improvements. That's exactly what you'd expect from the changes being made. If your time horizon goes out to 2030, and not just the end of the current month, UPS could help make you richer.
Worse than where it was before the pandemic?
The Wall Street pendulum tends to swing to extremes. During the pandemic, investors were overly enthusiastic about UPS stock. And now the shares are trading below where they were prior to the pandemic, as the pendulum has swung back in the other direction. But the company is slowly getting better.
If you have a contrarian bent and can handle some near-term uncertainty, which could include a dividend cut, UPS will likely be a much more attractive business in 2030 than it is today. And that should lead to Wall Street getting more interested in the stock if you give the investment enough time.
