Growth Element Makes UPS the Perfect Dividend Play

Growth is something investors don't look at with high-dividend yielders

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May 18, 2017
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United Parcel Service (UPS, Financial) is one of the world’s largest and oldest logistics companies. But despite being in the business for more than 100 years as a leader in the transportation and logistics segment, the company has never been more relevant than it is today. Thanks to the growth of e-commerce, UPS’s next 100 years looks more promising than the last 100.

But logistics is a boring industry. It is not as fanciful as the technology world is so it’s not really a surprise that UPS, despite its steady growth over the past several years, continues to trade at attractive valuation multiples. The stock has lost more than 8% of its value since the start of this year as it trades around 17 times earnings and 1.5 times sales. The biggest factor that needs to be considered is UPS's dividend yield of 3.18%, which makes it an extremely attractive dividend play for investors who are willing to hold on for the long term.

The UPS business moat

The logistics business is capital intensive, and it's a segment less prone to disruption than most others. How many technology companies will stay in the game for 100 years and look all set for the next 100? Not many. UPS invests billions of dollars every year to maintain its hubs, access points, field stocking locations, fleets of trucks, aircraft, IT systems and personnel.

No new company will be able to match the networks that big companies such as UPS and FedEx (FDX, Financial) have painstakingly established over the years. That’s a massive advantage these players have because the new player will never have the scale and pricing power to match them. With a moat as big as this, you can just buy the stock and forget it forever.

Financial strength

At the end of the first quarter UPS had $3.6 billion in cash and marketable securities and $19 billion in property, plant and equipment. Long-term debt stood at $12.93 billion with pension and retirement obligations amounting to $10.3 billion. Operating profit during the first quarter was $1.78 billion with interest expense touching $102 million for the quarter.

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UPS does not have a cash pile to sit on, thanks to the constant reinvestment that is required to keep the network in shape. Capital expenditure is one of the biggest expense items for the company, but it is also the one that’s responsible for the huge moat the company enjoys.

UPS's payout ratio was 54.7% in 2016. During the first quarter UPS paid $695 million in dividends while net income was $1.15 billion, representing a payout ratio of 60%. UPS clearly has plenty of room to increase its dividends over the next several years.

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Revenue Growth

This is the most important factor, and one that is overlooked by many investors as they hunt for dividend stocks. If the company is not in a position to keep increasing its sales, and finds the competitive landscape too tough to maintain sales growth, then sooner or later the effect will show on the "dividends paid" column. Procter & Gamble (PG, Financial) is a great example of this – a solid company with a great history, but sales growth has been on the decline and, as a result, dividends are barely moving.

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UPS does not face such issues. Revenue has been growing steadily over the past five years, and will continue to grow as more and more people start ordering online. At a 3.18% dividend yield, UPS is a steal that you should not miss.

Disclosure: I have no positions in the stock mentioned above and no intention to initiate a position in the next 72 hours.

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