United Parcel Service: A Dividend Growth Stock Expanding Its Services And Image

Apr. 3, 2015 1:58 AM ET  |  11 comments  |  About: United Parcel Service, Inc. (UPS)

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More...)

Summary

·         UPS's strategy to better accommodate its peak holiday deliveries caused it to overspend on holiday delivery preparations.

·         The company is working to address its past holiday delivery missteps by balancing cost efficiency with meeting peak package volume during its busiest delivery dates.

·         To help align costs, the company will expand capacity at shipping hubs in key areas to reduce the need for temporary workers and training costs.

·         UPS is also focusing on more profitable markets, such as the healthcare market, where a shipment must arrive expeditiously and at an appropriate temperature.

·         As the company resolves its past missteps and expands into more profitable markets, shareholders will be rewarded with a substantial dividend and share buybacks.

United Parcel Service (NYSE:UPS) is the world's largest package delivery company. Recently, the company's shares have been struggling near its 52-weeks lows as it struggles to overcome its past missteps. Over the past year or so, UPS attempted to adjust its Christmas-delivery plans, after being overwhelmed by packages it needed to deliver in 2013. The attempt to better handle its holiday deliveries caused it to overspend on delivery preparations in 2014. As the company moves forward and continues to adapt, it will start charging some customers more for peak-day shipping, and will avoid hiring too many seasonal workers. In 2014, UPS spent $675 million and hired 100,000 part-time workers to better prepare for its busy holiday season. During the company's holiday season in 2014, however, it experienced uneven package volume, with its busiest day experiencing deliveries 100 times more than normal, while workers sat idle on others. Subsequent to UPS's holiday 2014 missteps, the company now understands its problems, and understands that it needs to balance cost efficiency throughout its fiscal year, but also be able to handle its busiest delivery dates without spending too much money to do so.

UPS experienced $200 million in cost overruns in its 2014 fourth quarter. Such cost overrun will continue to adversely affect the company's results in 2015. In addition, increased pension expenses of $190 million and adverse currency effects will also depress its earnings in 2015. To help align costs this year, UPS will expand capacity at shipping hubs in key areas to reduce the need for temporary workers and training costs, and accelerate deployment of its technology that schedules deliveries more efficiently. It will also add peak delivery period surcharges. UPS has a history of rewarding its shareholders with substantial share buybacks and yearly dividend increases. The company's shares currently yield about 3.0 percent. We believe that potential investors have a unique opportunity to purchase UPS shares near their 52-week low and be rewarded with a substantial dividend yield while the company works to resolve its past missteps. In addition, UPS, as stated below, is beginning to move further into ancillary package delivery-related markets, such as the healthcare market, that will reward the company with increased profit margins.

Background

UPS is the world's largest package delivery service provider, but also offers various logistics and financial services. The company delivers packages domestically and internationally. It handles the majority of its daily domestic shipments using its ground delivery service. UPS delivers international shipments to more than 200 countries and territories worldwide, and provides delivery within one to two business days to the world's major business centers. The company's international services include export deliveries (packages that cross national borders) and domestic deliveries (packages that stay within a single country's boundaries). UPS provides domestic services in 20 major countries, and continues to invest in infrastructure and technology in Asia. The company also has a supply chain solutions division that provides logistics and distribution services, international trade management, and transportation and freight using multi-modal transportation. The company's capital business offers asset-based lending, global trade finance and export/import lending.

Fourth-quarter 2014 earnings

In the company's latest earnings report, UPS announced adjusted earnings per share of $1.25, unchanged from the year-ago quarter. The results were adversely effected by higher-than-expected expenses during the holiday season.
 Total revenue for the quarter increase 6.1 percent from the year-ago quarter to $15.9 billion, as the company experienced revenue growth across all the three of its divisions. UPS delivered 1.3 billion packages in the fourth quarter of 2014, an 8.1 percent increase.
 Its U.S. domestic package revenues increased 7.5 percent from the year-ago quarter to $10 billion, and operating profit for the division decreased 5.3 percent to $1.1 billion.
 International package revenues increased 5.9 percent from the year-ago quarter to $3.4 billion, and operating profit for the division decreased 0.2 percent. Supply chain and freight revenues increased 7.4 percent, and operating profit for the division increased 4.7 percent from the year-ago quarter to $179 million.

The company bought back more than 26 million shares for about $2.7 billion in 2014. UPS expects 2015 adjusted earnings to be in the range of $5.05-5.30, reflecting 6 percent to 12 percent growth from 2014. The company also maintained its long-term estimated earnings per share growth rate in the range of 9 percent to 13 percent.

Company begins emphasizing services to businesses

UPS is essentially known for delivering packages. The company, however, in recent years, has sought to change its image and focus more of its efforts on more profitable markets, where it can offer additional services; such as in the healthcare market, where a shipment must arrive expeditiously and at an appropriate temperature. To accomplish its goals of expanding it services, the company has built warehouse complexes with refrigeration. It has also become more active with respect to e-commerce package returns, an expensive logistical problem for e-retailers. UPS also assists brick-and-mortar retailers with tasks such as shipping packages from retail stores.

To communicate that UPS is more than just a package delivery company, it launched a new global ad campaign targeting businesses. The company's new advertising slogan is "United Problem Solvers", and is meant to communicate its increasing emphasis on providing services to businesses as global supply chains become more complicated. UPS's newest advertising campaign highlights services, including temperature sensitive health-care solutions, its ability to help grow small businesses and its e-commerce expertise for retailers. The company's advertising efforts do face some challenges, as it is so well known to many customers and potential customers as a package delivery company that it is difficult for UPS to change perceptions that it is more than a package delivery company. We believe that the company's package delivery expertise will serve it well in the new markets that it pursues, and UPS, as well as shareholders, will be rewarded by the company's efforts over the long term.

Our view

UPS's expanding healthcare-related business, shipment and productivity improvements will continue to drive growth. In addition, the company's strategic investments, technology-supported operations and enhanced global network will strengthen its market position and protect the company against unfavorable market dynamics.
 Adverse near-term factors the company faces include labor unionization issues, competitive threats from competitors such as FedEx Corp. (NYSE:FDX) and overall adverse economic turmoil.
 In addition, UPS has struggled with improving profitability as large e-commerce retailers such as Amazon.com (NASDAQ:AMZN) request and obtain larger discounts and the number of higher-cost residential deliveries related to e-commerce increase. Air express deliveries have also become less profitable as shippers increasingly choose slower, cheaper methods of shipping, or send documents digitally. In the current year, UPS is likely to experience growth in U.S. domestic revenues and improving international revenues, as lower pricing is offset by higher package volume. The company, however, will also strategize to improve its operating margins by better focusing on cost and efficiency when addressing the challenges it faces in making deliveries during peak delivery periods.

The current price-to-earnings ratio for UPS shares is about 29.45, and the shares yield 3.0 percent. UPS's forward price-to-earnings ratio is about 18.70 based on 2015 earnings estimates of $5.16, and about 16.75 based on 2016 earnings estimates of $5.77. The price-to-earnings ratio for the company's shares is at the lower-end of its 10-year historical price-to-earnings range in the mid-to-upper teens. Further, earnings estimates have fallen substantially over the last 3 months for the years 2015 and 2016. We believe that potential investors should wait for UPS's share price to drop to the $86.50-92.30 price range before establishing a full position (a forward price-to-earnings ratio in the range of about 15.00 to about 16.00, based on 2016 price-to-earnings estimates). A well-timed investment in UPS shares will allow an investor to be rewarded with a 3.0 percent dividend yield, substantial share buybacks and share price appreciation over the long term.