Dividend Report Card: United Parcel Service

In this series, we analyze financial metrics to begin answering the following questions about a company's dividend:

1. Over time, has this company steadily increased its payouts?
2. How sustainable is the dividend?
3. Does the company have room to further increase the dividend?

The Dividend Report Card wasn't designed as a buy or sell signal, but rather as a tool to gauge the health of a company's dividend. For a full explanation of each category, click here for a tutorial.

Today's pupil is United Parcel Service (NYSE: UPS), which posts a 2.85% dividend yield.

Dividend history

Source: UPS investor relations.

There's no question that UPS has a very good dividend track record -- it's either increased or maintained its dividend every year for four decades.

Nevertheless, the growth rate over the past five years was below 10%, so it scores a still-respectable 4 of 5 in this category.

Sustainability

Source: Capital IQ, a division of Standard & Poor's, as of March 21.

At first glance, UPS has a fairly decent balance sheet and its interest expenses are well-covered by operating earnings, but it does have more than $10 billion in debt on the balance sheet in addition to a few billion more in off-balance sheet rent obligations. Its legacy pension plan has also been a drain on cash flow, but according to management's latest conference call, its defined benefit pensions are now "over 100% funded." Morningstar gives UPS an "A+" credit rating.

More encouragingly, UPS's earnings-based payout ratio has improved from 81% in 2009 to 52% in 2010. Free cash flow cover is now over 2 times.

Growth

In the latest conference call, management said that "Share repurchases are expected to increase substantially, moving from $800 million in 2010 to approximately $2 billion in 2011. And dividends will continue to be a high priority for the company."

Oddly enough, the phrasing of this statement reminded me of the line from A League of Their Own when the two sisters are introduced as "This is our daughter Dottie, and this is our other daughter, Dottie's sister." Reading between the lines, it seems that UPS might consider its share repurchases more important to analysts' ears.

Analysts expect long-term earnings growth to be around 11%, but I would expect annualized dividend growth to be closer to the mid-single-digit rate of the past five years.

Competitors
An "ungraded" section of the dividend report card compares a stock's current yield against that of direct competitors. If it's too high relative to competitors' yields, the board could be tempted to slow the growth rate or cut the payout to bring it more in line with the industry average.

Here's another reason to think UPS's dividend growth will be modest. Its current yield of 2.85% is well above those of this peer group, so it may be in little hurry to raise the payout by a meaningful amount.

Pencils down!
With all the numbers in, here's how UPS's dividend scored:

UPS's dividend appears sustainable with modest growth potential and its grade of "A-" reflects that, but investors would be wise to monitor the company's use of free cash flow and its handling of the pension.

Have you added UPS to your watchlist yet? Well, what are you waiting for?