UPS’s latest quarterly results hint at a possible recovery.
UPS (UPS +1.43%) has been through some tough times lately, leading to falling sales and profit margins. This slump has affected its stock price, pushing the dividend yield up to 6.7%, which is quite a leap compared to the S&P 500 yield of just 1.2%.
While the third quarter showed continued weakness—with revenue dropping by 3.7% and adjusted earnings per share down by 1.1%—there were encouraging signs in other crucial areas. Can UPS turn things around enough to attract dividend-seeking investors?
Shifting focus from volume to margins
UPS has taken steps to lessen its dependence on risky ventures, like reducing its business with Amazon. Amazon is their largest customer but, interestingly, not the most lucrative one. UPS plans to cut its shipping volume for Amazon by over 50% by the latter half of next year. Last year, Amazon represented roughly a quarter of UPS’s shipments and more than 11% of its revenue. This strategy aims to focus on higher-margin clients.
As part of this approach, UPS is targeting $3.5 billion in annual cost savings by year-end. So far this year, they’ve achieved about $2.2 billion in savings, which included the closure of 93 facilities and the loss of 48,000 jobs.
According to CEO Carol Thome, these efforts are starting to yield positive results. “Our emphasis on earnings quality has led to solid outcomes,” he mentioned during the third-quarter results call. He pointed out a 9.8% increase in U.S. revenue per title compared to the same period last year, which, combined with cost-cutting measures, allowed for a slight uptick in U.S. operating margins from 6.3% to 6.4%.
Monitoring cash flow
UPS’s market challenges and strategic shifts have raised questions about its ability to maintain dividends while attempting to recover. The company reported only $2.7 billion in operating cash during the first half of the year, and after expenses, free cash flow was less than $750 million—well below the $2.7 billion in dividends and $1 billion in stock buybacks made in the first quarter. This cash flow figure is a stark decline from the previous year, when the company generated $10.1 billion in operating cash flow and $6.2 billion in free cash flow, comfortably covering its $5.4 billion dividend obligations.
This year, UPS had to tap into its balance sheet to offset the gap between cash inflow and expenditure. Consequently, long-term debt and finance leases increased from under $19.5 billion at last year’s close to $23.8 billion by the end of the third quarter, while cash and marketable securities stabilized at around $6.3 billion. Still, despite rising debt, the company holds a solid investment-grade corporate bond rating (A/A2).
On a brighter note, the cash flow saw a significant uptick in the third quarter as cost-saving strategies began to take effect. In that quarter, UPS generated $2.4 billion in operating cash flow and nearly $2 billion in free cash flow, helping to significantly narrow the gap.
Additionally, the firm managed to bolster its balance sheet by converting some real estate assets into cash through sale-leaseback deals on five properties. The combination of improved cash flow and asset sales led to a cash position of up to $6.7 billion at the end of the period. They anticipate needing around $1.6 billion of this amount to finalize ongoing acquisitions, particularly with Andlauer Healthcare. The outlook for additional cost savings in the fourth quarter is positive, and UPS aims to wrap up the year with $5 billion in cash after obtaining the necessary financing.
This acquisition also aligns with UPS’s strategy to expand profitable avenues, enhancing its medical logistics capabilities, which have been bolstered by earlier acquisitions like Frigo Trans and BPL.
Looking ahead, UPS expects cash flow to keep improving as revenue from this sector rises alongside further reductions in Amazon-related costs. Thus, the company appears to be in a strong position to sustain its dividends. Since going public in 1999, UPS has consistently maintained or increased its payments. The company describes its commitment to dividends as a “core principle” and a strong indicator of its financial stability, implying that any dividend cuts would likely only occur in a severe downturn.
Signs of recovery
UPS’s turnaround strategy is beginning to show progress, with better cash flow in the third quarter and the potential for additional growth as they continue to cut costs and pivot toward higher-margin clients. This emerging positive trend makes UPS a compelling option for investors who might be open to some risk in exchange for decent yields.
