History has taught us that often boring but steadily growing businesses can make the best long-term investments, especially if those companies have a strong commitment to rewarding investors with strong, consistent dividend growth.

United Parcel Service (UPS) is just such a company, slowly but steadily growing into a globe-spanning behemoth that has proven itself excellent at generating growing income and wealth for shareholders over time.

In fact, the company is one of the largest dividend stocks in Bill Gates’ concentrated stock portfolio (see analysis of all of Bill Gates’ dividend stocks here).

Let’s take a closer look at just what makes UPS so special and, more importantly, if this delivery master is likely to continue to do well for dividend growth investors in the coming years and decades.

Business Description

United Parcel Service is the world’s largest delivery service with 444,000 employees operating in over 220 countries and territories.

Thanks to a global fleet of 104,000 vehicles and 543 aircraft, UPS delivers 18.3 million packages and documents each day to around 10 million customers.

UPS’s business can be broken up into three business units: domestic package, international package, and supply chain & freight (the industrial logistics arm of the company), or SC&F.

Business Segment YTD Revenue YTD Operating Profit % Of Sales % Of Operating Profit
Domestic Package $27.4 billion $9.3 billion 62.3% 62.2%
International Package $9.0 billion $3.0 billion 20.5% 20.3%
Supply Chain & Freight $7.6 billion $2.6 billion 17.2% 17.5%
Total $44.0 billion $14.9 billion 100% 100%

Source: UPS Q3 2016 10-Q

While the domestic business continues to generate the majority of revenue and operating profits, the company continues to expand overseas and diversify into SC&F in order to become less dependent on just the U.S. economy.

As seen below, total revenue mix from U.S. domestic operations has decreased from 81% in 2000 to 63% in 2015.

United Parcel Service (UPS)

Source: UPS Investor Presentation

Business Analysis

While the company’s sales and earnings growth is lumpy due to the variable nature of the package delivery business, UPS has the classic signs of a wide moat company, which bodes well for its long-term prospects.

United Parcel Service (UPS)

Source: Simply Safe Dividends

United Parcel Service (UPS)

Source: Simply Safe Dividends

Specifically, note how long-term EPS growth has outpaced sales growth, and free cash flow (FCF) growth has outpaced EPS growth.

This shows that UPS is able to achieve ongoing efficiency improvements via its massive economies of scale that allow it to consistently grow its profits over time and achieve the industry’s best margins.

United Parcel Service (UPS)

Few companies can afford to invest in all of the hard assets required to efficiently run a global delivery service business. Furthermore, new or smaller rivals lack the brand recognition enjoyed by UPS, which is important because customers expect their packages to be reliably delivered in a time-sensitive manner.

These are all reasons why the industry is heavily concentrated with a small handful of operators dominating the space.

Another key to UPS’ success is excellent management, courtesy of current CEO David Abney, who before taking top spot served as COO and president of UPS International.

Abney has literally spent his entire professional life with UPS, starting at age 18, and has been climbing the corporate ladder for 40 years.

Along the way he’s developed a finely honed skill at learning how to optimize efficiency at the company’s vast network of distribution centers and beat rivals like FedEx in terms of international expansion.

Take a look at both companies’ export volume growth over the last decade.

United Parcel Service (UPS)

Today UPS continues to invest heavily into cost optimization through projects as ORION, or On-Road Integration & Navigation, which utilizes route optimization to reduce delivery time, improve reliability, and cut fuel waste.

UPS estimates that ORION alone will help cut $300 million to $400 million in annual operating expenses, and that’s just one major efficiency initiative the company is working on.

United Parcel Service (UPS)

In addition, the company is pouring billions into hub automation (especially in Europe) to maximize the efficiency of its workforce. For example, by 2019 UPS expects 50% to 60% of its packages to be handled by robots, which should boost hub productivity by 20% to 25%.

Further efficiency gains come from computerization of delivery times to help minimize missed deliveries and improve customer satisfaction, further building up brand equity and improving pricing power.

This allows UPS, despite the monstrously capital intensive nature of its industry, to generate truly amazing returns on shareholder capital, including a return on invested capital north of 30%.

Company Operating Margin Net Margin FCF Margin Return On Assets Return On Equity Return On Invested Capital
UPS 13.2% 8.3% 6.4% 12.9% 214.1% 30.3%
Industry Average 8.8% 5.2% NA 7.7% 29.3% NA

Source: Morningstar

Best of all, thanks to management’s excellent capital allocation (including strong, consistent share buybacks of 2.4% CAGR over the past five years), management expects adjusted EPS to grow strongly in the coming years.

As seen below, adjusted earnings per share are expected to increase 9% to 13% annually from 2016 through 2019. Strong earnings growth bodes very well for the company’s dividend growth prospects.

United Parcel Service (UPS)

Key Risks

No company, not even a blue chip like UPS, is without risks. There are three risks in particular that potential investors need to be aware of.

The first is that UPS’ business is cyclical, meaning sales, earnings, and cash flow will fluctuate based on the health of the U.S. and global economies. That’s especially true given the capital intensive nature of the business which can play havoc with short-term results (and result in share price volatility).

For example, UPS just announced that it was purchasing 14 Boeing (BA) 747-8 Freighter jets with an option to buy 14 more between 2017 and 2020. Each plane costs $357.5 million, meaning that just these 28 planes alone would end up costing UPS over $10 billion.

Depending on the exact delivery date of these planes, quarterly or annual EPS and FCF could take a substantial hit that could disappoint Wall Street and make the dividend appear less safe than it really is.

And speaking of capital intensity, we can’t forget that delivery companies carry a lot of debt on their balance sheets.

While UPS’ debt load (more on this later) isn’t anywhere close to dangerous levels, investors will want to watch it over time to make sure that management doesn’t get so enthusiastic about returning cash to shareholders that it creates dangerous amounts of unmanageable debt.

And finally, we can’t forget about competition, both from other delivery companies such as Fedex (FDX) but also from Amazon (AMZN), which has recently launched its own delivery company.

While the immense scope of Amazon’s delivery needs, and online retail delivery in general, are so vast that this isn’t likely to prove an existential threat, investors will want to make sure that UPS stays on top of the situation.

After all, if Amazon becomes a major rival to UPS and FedEx or merely takes its deliveries in-house, that could eliminate a major growth catalyst for UPS and hurt its dividend growth prospects going forward.

Dividend Safety Analysis: United Parcel Service

We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth

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