UPS (UPS 0.49%) is undergoing a major strategic transformation. The global logistics company is shrinking its business to grow its margins and profitability. It's a bold strategy that the company hopes will enhance shareholder value over the long term.
The company is in a transitional phase right now. Here's a look at where it expects to be in one year.
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Streamlining its business
Earlier this year, UPS made the strategic decision to reduce its reliance on top customer Amazon (AMZN +1.10%). The logistics giant plans to cut its Amazon shipping volumes by more than 50% by the end of next year. This strategic shift will enable UPS to focus on its more profitable customers.
Amazon had accounted for around 20% to 25% of the company's volumes last year. However, the e-commerce giant only contributed about 11% of UPS' revenue. As a result, it wasn't making as much money on these volumes as it does with other customers.
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As part of its move to reduce its Amazon volumes, UPS has undertaken a major cost reduction initiative to streamline its operations. The company aims to cut $3.5 billion in costs by the end of this year as it reconfigures its network to reflect lower future Amazon volumes by closing buildings and reducing its workforce.
The company had already achieved $2.2 billion of cost reductions by the end of the third quarter. It had cut 48,000 jobs and closed 93 buildings as part of its realignment. It had also reduced its Amazon volumes by over 21%.
UPS' strategy was already starting to deliver some improvements in its financial results. While its total revenue declined by 3.7% during the third quarter, its U.S. revenue per piece increased by 9.8%. That helped boost its margins during the period. UPS also generated significantly more free cash flow during the third quarter ($2 billion) than it did during the first half of the year ($742 million) as its cost-cutting initiatives started to deliver results.
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Bulking up this healthier business segment
UPS wants to shift more of its business mix away from Amazon to focus on growing its volumes with more profitable customers. One of its more profitable business lines is healthcare logistics.
The company has made a couple of notable strategic moves to enhance its healthcare logistics capabilities. Last year, UPS bought Frigo-Trans and its sister company BPL, which operate a network of temperature-controlled warehouses and other healthcare logistics assets throughout Europe. The company followed up on that deal by acquiring Andlauer Healthcare Group this year to enhance its temperature-controlled logistics capabilities in North America. These moves will help accelerate the expansion of its healthcare logistics platform, positioning the company to deliver more profitable growth in the coming years.
Remaining committed to the dividend
UPS' strategy shift, along with other issues such as market headwinds, has weighed heavily on the share price. The stock has declined by more than 50% over the past three years. That sinking stock price has driven up its dividend yield to nearly 7%. This high yield has income-focused investors growing concerned about the dividend's sustainability.
On the one hand, income investors have reason to be concerned. UPS had only generated $2.7 billion of free cash flow through the first nine months of this year, which wasn't enough to cover the $4 billion it paid out in dividends. That has forced the company to rely on its balance sheet to bridge the gap. Even with using its balance sheet to fund a portion of its dividend outlay, $1 billion of share repurchases in the first quarter, and the recently closed $1.6 billion Andlauer acquisition, UPS expects to end this year with $5 billion in cash.
That healthy cash position, along with the company's cost-cutting initiatives, drives its conviction that it can maintain its dividend during this transitional phase. The company has maintained or increased its payment every year since going public in 1999, including raising it earlier this year. UPS believes its commitment to the dividend is one of its core principles and a hallmark of its financial strength. These factors suggest that the company won't cut its dividend in the next year.
UPS should be a stronger company one year from now
UPS is shrinking its Amazon volumes to focus on growing its more profitable businesses, such as healthcare logistics. While this strategic pivot has weighed on the company's share price, it has started to show signs of working. As a result, UPS should be in a better position a year from now, including having a more sustainable foundation under its high-yielding dividend.
