Back Into United Parcel Service (NYSE:UPS)

It’s been a little over two months since I sold my shares in United Parcel Service, Inc. (NYSE:UPS) at a small profit, and in that time the shares are down about 14.4% against a loss of about 3.5% for the S&P 500. Obviously, a stock that’s trading at $154 is a safer investment than the same stock when it’s trading at $182, so I thought I’d review the name again to see if it makes sense to buy back in at current prices. I’ll make that determination by looking at the latest financial results, and by looking at the valuation. Additionally, I think this investment, like all potential stock investments at the moment, should be put in the context of the current interest rate environment. What I mean by this specifically is that in the domain of investing, everything is relative. When risk free government bills and bonds were offering investors only 1%, there was no real alternative to stock ownership. Now that the 10-Year Note is offering about 4.65%, there very much is an alternative. In such a world, a stock had better offer quite a decent, safe yield in my view.

We’re all busy people, and I’m assuming that some of you don’t want to read as I indulge in my odious tendency to brag about a “good call.” For these reasons, I am including a “thesis statement” paragraph at the beginning of this article. I do this to give the “gist” of my thinking up front, without exposing you to too much “Doyle mojo.” You’re welcome. I’m actually going to be buying a couple hundred shares of United Parcel Service when the market opens on October 10. I’m doing this because the performance so far in 2023 was actually fairly good, especially when compared to the pre-pandemic era. Additionally, I think the dividend is reasonably well covered. Additionally, I think there’s room for dividend growth over the next decade. Given that, the spike in the yield, to only 50 basis points below the risk free rate, suggests that shares are much more attractively priced now. In other words, the reward of decent cash flow adequately compensates for the risk of investing in this stock in my view. Thus ends my thesis statement. If you read on from here, that’s on you. I don’t want to read any complaints in the comments section about proper spelling or my tiresome tendency to brag.

Financial Snapshot

Before getting into the forecast, I thought I should write briefly about how I did as a forecaster. I think I demonstrated the wisdom of the old quip: predicting is hard, especially about the future.

In my forecast of UPS earnings, I massively overestimated the company’s 6-month revenue by about $1.2 billion. On the bright side, though, in spite of this revenue forecast miss, my prediction for operating profit was off by only about $88 million. My forecast was enough for me to take profits, and it seems that this has been one of the rare occasions when the market and I have agreed, as the stock has dropped precipitously since.

The financial results are actually pretty rough in my estimation. Relative to the same period a year ago, revenue and net income were down by 8.5% and a whopping 27.9% respectively. Because of a rather sizable buyback program, EPS were down by “only” 26.6%. Additionally, I think the $3.5 billion spent on buybacks over the past year would have been better spent cleaning up the capital structure, given that debt remains stubbornly high at $20.7 billion.

On the bright side, things look better than they did heading into the pandemic. When we compare the first six months of 2023 to the same period in 2019, revenue and net income are up very nicely by 28% and 42.2% respectively. At the same time, the capital structure is much improved from then to now, with obligations down by about $2.6 billion, and cash and marketable securities higher in 2023 by about $3 billion. So, this year has been weaker than 2022, but we should remember that 2022 was very much a banner year for the firm.

Additionally, even with the slowdown we’ve seen so far in 2023, I remain of the view that the dividend is well covered, and for that reason I’d be happy to buy the stock at the right price.

The Stock

As we know by now, “the stock” and “the business” are actually very different things. The business is a logistics company, a courier, while the stock is a piece of virtual paper that represents certain rights to the ownership of the business. The stock confers certain rights (voting, receipt of dividends etc.) on the owner, but it moves up and down quite dramatically in price. The stock price changes are based on the ever-changing moods of an often capricious market for stocks, and those moves may be the result of things happening at the business, but the stock can move up and down based on changes in short-term interest rates, and changes in the appetite for “stocks” as an asset class. Additionally, this stock may be affected by what’s going on in the oil market, given the impact of the fuel expense. Labour negotiations obviously also had a recent impact. To frame this analysis slightly differently, consider the stock’s performance since the company released its latest financial results. They may not have blown the doors off, but is a 14% drop in the stock warranted? Is this company 14% less valuable over the past two months?

Anyway, in my experience, investors who buy shares when they’re more cheaply priced tend to do better. If you’re a regular, you know that I measure the cheapness of a stock in a few ways ranging from the simple to the more complex. On the simple side, I look at ratios of price to some measure of economic value, and I like to see a stock trading at a discount to both the overall market and its own history. When I last reviewed UPS, shares were trading hands at a PE ratio of about 14.74 times. Today, the shares are about 9.15% cheaper on that basis, per the following:

Source: YCharts

Source: YCharts

You may remember reading above that I think investors who buy shares when they’re cheaper do better. In my view, “cheaper” can have a few meanings. Obviously, lowest price is one example of cheaper. Another one of my definitions of “cheaper” is “less risk per unit of return.” So, if investment A costs fewer units of risk and offers up the same returns as investment B, then investment A is, definitionally, cheaper. My regular victims know what I’m about to write about: the delta between the dividend yield and the risk free rate. When I last reviewed this name, the dividend yield on the stock was about 2.6%, which was significantly below the risk free rate. In other words, government bonds offered higher returns at significantly less risk, and thus they were much cheaper than the common stock. Fast forward to the present, and the dividend yield has jumped to over 4.1%. This is still about 50 basis points below the 10-year risk free rate, but I’m of the view that there’s some potential for the dividend to increase from current levels. Thus, I don’t think it unreasonable to assume that this year’s 4.13% on the $154 stock, might turn into a 5% or even 6% return over the next few years. Thus, I think the shares represent fairly decent value given the income they may spin off over the coming decade.

For the above reasons, I’ll be buying a couple of hundred shares of UPS at the first available opportunity on October 10.