At the beginning of February, United Parcel Service Inc. (NYSE:UPS) announced that it was raising its quarterly dividend by 49%. This is one of the largest increases this year amongst the big-cap names in the market.
Its not like UPS is just beginning its dividend growth streak or is starting from a low base. The company has raised its dividend for 13 consecutive years, with a compound annual growth rate (CAGR) of nearly 7% over the last decade.
This Powerful Chart Made Peter Lynch 29% A Year For 13 Years
How to calculate the intrinsic value of a stock?
Lets take a closer look at why the company feels that such an increase at this time was warranted.
Company background and results history
UPS is the largest air and ground package delivery company in the world. The company has operations in more than 220 countries and averages more than 25 million package deliveries per day in the U.S. alone. UPS has annual revenue of more than $97 billion and a market capitalization of $177 billon.
UPS reported fourth-quarter and full year-2021 earnings results on Feb. 1. For the quarter, revenue grew 11.5% to almost $28 billion. Adjusted earnings per share of $3.59 compared favorably $2.66 in the previous period.For the year, revenue gained 15% to $97.3 billion while adjusted earnings per share of $12.13 was considerably ahead of the $8.23 the company produced in 2020.
UPS has a history of growing both its top and bottom lines. Revenue has a CAGR of 6.7% over the last decade. Excluding last years performance, the previous 10-year period saw a still solid CAGR of 5.3%. Earnings per share have increased at an annual rate of 11.6% since 2012. The 2011 to 2020 period had a growth rate of 7.7%.
The company has seen business grow at a steady rate for a long period, but the most recent results were especially impressive. These results were not on the back of weak comparable numbers either. For 2020, revenue and adjusted earnings per share grew 14.2% and 9.3%, respectively.
Business has been doing well since the start of the Covid-19 pandemic as demand for shipments has risen at a very high rate. What might have been a one-time tailwind appears to have been sustained into the most recent year as people are unwilling to give up the convenience of delivery.
Wall Street also predicts these tailwinds will be consistent, as analysts expect revenue to grow nearly 5% in 2022 and earnings per share to improved 6.2% to $12.88. Both figures are also expected to rise in to 2023.
Dividend growth history and recession performance
UPS depends on a healthy economy to drive its business as it can be susceptible to recessions. Listed below are the companys adjusted earnings per share before, during and after the Great Recession:
2006 adjusted earnings per share: $3.86
2007 adjusted earnings per share: $4.11 (6.5% increase)
2008 adjusted earnings per share: $3.50 (14.8% decrease)
2009 adjusted earnings per share: $2.31 (9.7% decrease)
2010 adjusted earnings per share: $3.56 (54.1% increase)
2011 adjusted earnings per share: $4.23 (18.8% increase)
2012 adjusted earnings per share: $4.53 (7.1% increase)
In total, UPSs adjusted earnings per share declined almost 44% from 2007 to 2009 as the company dealt with the impact of the Great Recession. UPS did establish a new high for adjusted earnings per share by 2011 and has made a new high each year since, speaking to the companys ability to rebound against a difficult economic backdrop.
Unlike many companies, UPSs buybacks havent been a leading contributor to earnings growth. The company has retired just 1% of its share count over the last 10 years. Net profit has increased by 10.4% annually over this period of time, much higher than revenue growth. This is because UPS has become much better at extracting profit from its revenue as the net profit margin has improved from 8.1% in 2012 to 10.9% last year.
UPS did manage to raise its dividend 9.8% in total from 2007 to 2009, showing that the company can be counted on to grow its distributions even in the face of challenges in its business.
Shareholders have seen their dividends per share grow just under 7% for both the last five- and 10-year periods, providing evidence of a dividend that was consistently growing.
Payout ratios
So, if the company has been very consistent and fairly conservative in its dividend growth over the medium- and long-term, why the nearly 50% increase?
The answer is that the business performed very well during 2020, was able to maintain those tailwinds into the most recent year and looks to perform even better in the current year. This means that the companys payout ratios are still in a very healthy position.
Shareholders received $4.08 of dividends per share in 2021, giving UPS an earnings payout ratio of 34%. This was the lowest ratio in more than a decade and is well below the 10-year average payout ratio of 51%. Using estimates for this year, the forecasted payout ratio is still below the long-term average at 47%.
Free cash flow is a similar situation. UPS paid out dividends of $3.437 billion in 2021 while generating free cash flow of $10.8 billion giving the company a free cash payout ratio of 32%. The three prior years had an average payout ratio of just under 70%.
Some might argue that 2021 could be more of an outlier and that the free cash flow payout ratio could move back to where it was in the near-term as free cash flow falls. If so, then UPS, which is expecting to distribute $5.2 billion of dividends this year, could end up with its dividend growth streak in trouble.
But this doesnt appear likely. The company is expected to see increases in both the top- and bottom-lines in 2022. Leadership also expects that the operating margin to be 13.7%, which compares to 13.1% last year.
The profit margin should also be higher than it was last year as total debt has declined in the past few years. Interest payments should be lower as a result. Essentially, UPS is expected to see a modest rise in revenue for 2022, an increase in its margin and likely less interest expense on its debt.
It is likely that free cash flow will be similar to what was produced last year. Even if free cash flow were to decline 25% from 2021, this would still leave UPS $8.1 billion in total. With slightly more than $5 billion of dividends, the payout ratio would be 58%, still lower than the near-term average.
Therefore, UPSs dividend, even after a large increase, can be considered safe from both an earnings and free cash flow angle.
The impact of debt of dividend security
The last area that I consider when evaluating the safety of a companys dividend is its debt obligations.
UPSs interest expense totaled $694 million last year. The company ended the year with total debt of $25.5 billion, giving UPS a weighted average interest rate of just 2.7%.
The chart below shows how high the companys weighted average interest rate would need to rise before dividends were not covered by free cash flow:
UPS's Massive Dividend Raise Reflects Strength
Source: Authors calculations
As shown above, UPS would need to see its weighted average interest rate rise above 31.5% before free cash flow wasnt able to accommodate dividend payments.
Lets suppose that 2021 was a high mark for free cash flow and this figure were to decline by 25% to $8.1 billion and the company was to distribute $5.2 billion of dividends this year. What impact would that have on this scenario?
UPS's Massive Dividend Raise Reflects Strength
Source: Authors calculations
In this case, the weighted average interest rate would need to rise to more than 14%, significantly higher than the current figure.
Therefore, debt does not appear to be an obstacle to UPSs ability to pay and raise its dividend, even if free cash flow were to decline.
Final thoughts
Shareholders of UPS received a dividend increase that was approximately seven times the long-term average for the payment distributed on Thursday.
The company was in a position to do so because its business is quite strong. UPS's business prospered during the beginning of the pandemic and, if most recent results and analysts forward estimates are any indication, the company should see additional growth in the coming years.
Even after the increase, UPSs projected payout ratios are within the normal historical range and debt obligations dont look like an obstacle to future growth. And if free cash flow generated in 2021 is the new type of normal for the company, then investors can likely expect to see high rates of dividend growth going forward as well. This suggests that UPS is now a much more attractive option for income-oriented investors.
