If You’re Looking For Increasing Dividends, I’d Definitely Consider This Stock on a Pullback

YieldWhenever I’m looking for a stock to add to my portfolio, I start thinking about themes.

Themes, or stories, about the way the world does business and certain industries that are likely to do well over the next decade or two is a good way to think about investing.

Take the way people shop, for instance.

There’s no doubt that people are buying more items online, as e-commerce has taken off in a big way over the last few years.

[ad#Google Adsense 336×280-IA]It’s predicted that US retail e-commerce sales will add up to almost $500 billion by 2018, up from $167 billion in 2010.

And I propose that there’s an easy way to profit from that theme.

Shipping.

The more items people buy online, the more boxes there are to ship to these people’s homes. And with that volume comes increasing profit.

A great company to consider here is United Parcel Service, Inc. (UPS).

They’ve been around for more than 100 years and have built themselves into the world’s largest package delivery company. That kind of size allows them economies of scale that smaller competitors will naturally lack. Furthermore, they have the resources to continue growing and benefiting from the sure rise in not only e-commerce, but shopping in general.

Their massive size and scale allows them the kind of reach that is really unparalleled. So as global shipping inevitably increases, UPS should be able to reach more customers than competitors. And because there are only a few global players, competition is limited and pricing is attractive.

UPS handled, on average, more than 16.9 million packages each day in 2013, which was up by 4% year-over-year. That’s an incredible number of shipments being coordinated around the world, and UPS’s logistics is second to none.

But I can talk about the company all day long. Let’s take a look at some of their numbers. If a picture is worth 1,000 words, financial statements are worth much more.

The company grew revenue from $36.582 billion in fiscal year 2004 to $55.438 billion in FY 2013, which is a compound annual growth rate of 4.73% over the last decade. Not bad, but perhaps not as strong as one might expect for a global shipper.

The top line just gives us part of the picture, however. Profit tells us a lot more about the health and overall growth of a company, so let’s see what UPS has done there.

Earnings per share increased from $2.93 to $4.61 over this period. That’s a CAGR of 5.16%. Again, not excellent, but I do think this company is extremely well-positioned to grow strongly in the global shipping market.

S&P Capital expects EPS to compound at a 12% annual rate over the next three years, citing increasing volumes and improving margins. Improvement looks to be on the horizon.

One aspect of a company I always look for is whether or not they’re prone to share profits with shareholders in the form of a dividend. More specifically, I only invest in companies that regularly and consistently pay increasing dividends to shareholders, qualifying their common stock as dividend growth stocks. After all, cash is good. But increasing cash flow is much better. And it serves as proof that profit from underlying business operations is indeed increasing, as cash can’t be faked.

In this regard, UPS has done pretty well. Though they held their dividend static for a couple of years through the Great Recession, they’ve increased their dividend for the past five consecutive years.

This qualifies them as a “Challenger” on David Fish’s Dividend Champions, Contenders, and Challengers list, which is a document that tracks more than 600 US-listed stocks with at least five consecutive years of dividend increases.

UPSAnd over that five-year stretch, the dividend has increased at an annual rate of 8.3%.

That rate is higher than that at which profit has grown, so future growth will have to more or less match earnings.

The stock offers a yield of 2.43%, which is attractive in this market.

However, the payout ratio is moderately high, at 66.5%. A 50% payout ratio (the amount of dividends paid out against earnings) is preferable, as it allows a lot of flexibility on the part of the company. But because UPS has grown the dividend faster than earnings, we see an inflated payout ratio. But the dividend is still well-covered and profit growth is anticipated to pick up, so I expect the payout to not only be fine, but increase in line with business growth.

UPS’s balance sheet is leveraged, but not a concern. The long-term debt/equity ratio is 1.62, while the interest coverage ratio is 18.56. The interest coverage ratio indicates that UPS really has no problem with their debt, as annual EBIT covers interest expenses more than 18 times over.

Their profitability compares well to competitors, though their return on equity seems inflated due to lower common equity (which also explains the debt ratio). Net margin has averaged 5.67% over the last five years, which was dragged down by really a one-off year in FY 2012. ROE averaged 50.94% over that period.

Worldwide shipping is a great trend to capitalize on. It may seem like an old trend that has had its best days behind it, but the numbers just paint a totally different picture. Even traditional brick & mortar retailers are seeing e-commerce ramp up tremendously. And shippers can make more money with packages going to individual customers over one retail center.

The primary drawback I see with this company are the capital needs, as there’s substantial infrastructure and costs at play here. That’s something that can limit the possible returns to shareholders, as the performance for the stock and the business over the last decade shows.

The stock trades hands for a P/E ratio of 27.18 right now. This appears to be rich in comparison to the broader market, but it’s actually in line with the industry average and much lower than UPS’s five-year P/E ratio average.

I valued shares using a dividend discount model analysis with a 10% discount rate and a 7% long-term growth rate. I think that’s possibly a bit aggressive considering the rather high payout ratio and UPS’s demonstrated underlying EPS growth over the last 10 years. However, I’m also accounting for the forecasts for higher growth moving forward and the potential for the company. The DDM analysis gives me a fair value of $95.59.

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Bottom line: United Parcel Service, Inc. (UPS) is a well-known brand with a global platform that is extremely well-placed to continue capitalizing on the trend toward the increasing shipping of packages. There are potentially billions of untapped consumers around the world that have yet to become UPS customers. And increasing e-commerce points to increasing volume. Though they have a somewhat short dividend growth record, bigger growth ahead points to more cash flow in shareholders’ pockets. I’d definitely consider this stock on a pullback if you’re looking for increasing dividends to be shipped your way.

— Jason Fieber

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