United Parcel Service (UPS) stock has been hit hard in 2023 and is now down over 20% year to date following its third-quarter results which fell short of expectations. The sell-off has been particularly brutal within the context of UPS’ historic run. On Jan. 7, 2022, UPS reached an all-time intraday high of $219.45. And now less than two years later, UPS stock finds itself down over 40% from that high.
Here’s why UPS stock is out of favor, the reasons behind its weak performance, why UPS ultimately has what it takes to be an excellent source of passive income, and why now is a good time to buy this reliable dividend stock.
UPS’ once-blistering growth rate is cooling off
The outbreak of the COVID-19 pandemic weakened business-to-business deliveries. But it was a boon for business-to-consumer deliveries as folks were stuck at home and consumer spending soared.
In the table above, you can see that UPS enjoyed a period of top- and bottom-line growth, along with gobs of free cash flow (FCF), and operating margin expansion. Revenue peaked in 2022, but net income, FCF, and operating margin peaked in 2021.
UPS was upfront about the challenges heading into 2023. The package delivery industry is cyclical. And after a multi-year growth period, paired with economic challenges and inflation, it was probable that UPS would be unable to sustain its growth in the short term. But the results have been worse than expected. So much so that UPS is now guiding for full-year consolidated revenue of $91.3 billion to $92.3 billion and an operating margin of 10.8% to 11.3%.
For context, UPS had initially guided for $97 billion to $99.4 billion in revenue and a consolidated adjusted operating margin between 12.8% and 13.6%. So the expectation going into the year was that revenue would only fall by a couple of percentage points, but operating margin would actually be better and could even come in at an all-time high.
That clearly hasn’t played out, and UPS has gone from a company that investors could count on to beat expectations to one that continues to guide down and is on track to badly miss its initial 2023 forecast.
UPS’ long-term growth plans are working
UPS continues to miss expectations and is undergoing what looks to be the beginning of a cyclical downturn. And for that reason, the stock deserved to fall. Understandably, investors will have a hard time getting excited about UPS stock right now.
But as bad as its 2023 performance has been, it would be a mistake to lose sight of what the company is doing right. The two big areas of focus for UPS over the last few years have been small and medium-sized businesses (SMBs) and healthcare.
Its digital access program (DAP) is tailor-made for SMBs. On its Q3 earnings call, UPS said that DAP revenue is expected to total $3 billion for 2023 — an incredible achievement considering it was just $1.3 billion in 2021. UPS expects to notch over $10 billion in healthcare revenue this year or around 11% of total revenue. In 2021, healthcare revenue was $8 billion.
So from DAP and healthcare alone, UPS is on track to earn about $2.7 billion more in revenue than in 2021. But overall, revenue is expected to be over $5 billion less than in 2021 — which highlights the importance of DAP and healthcare and, on a less optimistic note, the poor performance of the broader business.
Supporting spending and dividends
UPS may have missed its revenue and operating margin guidance. But the company remains on track to spend $5.3 billion on capital expenditures and $5.4 billion on dividend payments this year, which is what it guided for when it reported its fourth-quarter 2022 results. Hitting the capital expenditures goal sets up further growth in programs like DAP and healthcare. And investors are already seeing how important those programs are during a challenging time for UPS.
UPS initially guided for $3 billion in 2023 share repurchases. It now expects just $2.25 billion in share repurchases, which is understandable. Scaling back a share-buyback program during challenging times is one thing. But what investors don’t want to see is an inability to fulfill dividend obligations or invest in future growth through capital expenditures. UPS isn’t in that position. And it is more than capable of maintaining its $1.62 per share quarterly dividend, good for a forward yield of 4.7%.
UPS has a rock-solid balance sheet
Another key factor that should give investors the confidence needed to own UPS stock over the long term is its strong balance sheet.
UPS took advantage of outsize gains over the last few years to pay down debt, and in turn, lower its debt-to-capital and financial debt-to-equity ratios. A cyclical company needs to maintain a healthy balance sheet so that it can handle a prolonged downturn. That way, a company can lean on its balance sheet to fulfill capital commitments and avoid breaking promises.
The sell-off is a buying opportunity
UPS isn’t the complete package it was a couple of years ago, but the stock has now sold off considerably. And if you look at where UPS is today compared to where it was before the pandemic, the company is far stronger in terms of the end markets it is tapping into and its efficiency. And yet, the stock is now up just 28% over the last five years.
Investors seem to be discounting the strides UPS has made, not to mention the dividend is 78% higher today than it was five years ago. All told, the UPS sell-off has gone too far. Now is the time to buy this reliable dividend stock, sit back, and let the cycle play out.
— Daniel Foelber
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Source: The Motley Fool