United Parcel Service (NYSE:UPS) is currently a selection for the real-money Inflation-Protected Income Growth portfolio. In a recent update, portfolio manager Chuck Saletta indicated that he'd consider selling United Parcel Service's shares if they reached above $100.
As of Tuesday's close, UPS' stock surpassed that level, ending the day at $100.30. http://finance.yahoo.com/q/hp?s=UPS&a=10&b=5&c=2013&d=10&e=5&f=2013&g=d As a result, it's time to revisit that analysis and decide whether it really is time to part ways with the company's shares.
Three things to consider
Three key factors were behind the original decision to consider selling UPS' stock above $100: its valuation, its balance sheet, and its dividend. Before the stock gets sold, all three should be reviewed again, in light of the new earnings the company just released, to see if the sell story is still as compelling.
Balance sheet: UPS' debt-to-equity ratio remains stubbornly high, at 3.3. The company took a charge in its December 2012 quarter to help fund its pension plan, which cut its equity. In the capital-intensive package delivery business in which UPS operates, some level of debt is inevitable, but too much debt can stifle the company's flexibility in tough times. Total debt is down a couple hundred million dollars since that December 2012 quarter, but it's not low enough to stop worrying.
Dividend: While UPS' payout ratio currently appears to be more than 100% of earnings, that's largely an artifact of the company's pension charge in the December 2012 quarter. The reality is that its dividends are easily covered by its cash from operations. As a result, UPS' dividend does not look like it's at substantial risk of being cut. However, with the company's heavy debt load relative to its equity, it will be tougher for UPS to significantly raise its dividend in the near future.
Valuation: After including its most recently reported quarter, UPS now looks to be worth around $85.6 billion, based on a discounted cash flow analysis. While that's up from $74.9 billion when United Parcel Service was originally selected, it's below its recent $94.1 billion market capitalization. With that change, UPS looks to be priced within around 10% of fair value, making the sell decision less clear-cut than had its value estimate not increased.
Net: Hold and review again
Looking across all those three factors updated with the most recent quarter's data, the case to sell isn't quite as strong as it looked to be previously. As a result, UPS will remain in the iPIG portolio for the time being, but it will be kept on a fairly tight leash.
If its share price continues to rise and gets past $120 by the end of this quarter, the decision to hold on will be revisited. Otherwise, this quarter of the year is huge for shipping companies like UPS thanks to holiday shopping. A strong quarter could result in either another upwards revision in the valuation estimate or an improvement in its balance sheet.
Additionally, the company will review and potentially increase its dividend early next year. A strong dividend increase (well supported by cash flows, of course) would help allay fears that the company's debt load is hampering its flexibility.