UPS, a Good Dividend Growth Source, Is Trading on a Discount

 | Apr 19, 2017 | 11:00 AM EDT
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One of the enduring, long-term trends of our time is the steady growth of ecommerce, both in absolute volume and in overall share of the retail space. Brick-and-mortar retail establishments of various kinds have been losing market share thanks to the growth of e-commerce.

In my opinion, this trend is going to be a long-term one; it is one reason why I tend to stay away from retail businesses that aren't firmly behind it.

Of course, the most obvious play is the giant of the ecommerce sector, Amazon (AMZN) . But the stock is prohibitively expensive and doesn't pay a dividend, which for me is something of a deal-breaker.

One of the simplest ways to get behind this trend might be with the shipping companies that ship the stuff that consumers buy. United Parcel Service (UPS) has dipped and is just a couple of percentage points from its 52-week low.

Year to date, the shares of UPS are also down 9.1%. I believe that now is a good time to look into buying into this company.

Successful logistics in ecommerce these days means very large economies of scale, not only as a competitive advantage but also as a barrier to entry for potential newcomers. Air and ground logistics are a big part of this, but as of late UPS has also been aggressively investing in information technology and automation in order to drive down per unit cost while volume steadily increases.

Source: UPS

The cost curve chart above is a busy chart. UPS's heavy investment in information technology has optimized routes for drivers, referenced here as "Orion," and has resulted in 9% fewer stops and six to eight fewer miles driven per driver.

Facility automation has also helped "flatten the cost curve." Robotics are helping to improve productivity per head, as UPS looks to go from 40% of logistics centers being "highly automated" to 100%. With these things in mind, it's easy to see how UPS is keeping costs flat despite steadily growing package volumes.

On the demand side of the equation, UPS is working on 70 new package and hub projects around the world. This should lead to improved efficiency and connectedness of hubs, and of course a higher capacity by which to ship increasing volume. That's a good thing, because online retail is forecast to grow at 3x GDP expansion.

The company's management expect that to translate to forward revenue growth of somewhere between 5%-7% this year. As growth of ecommerce is a rather long-term trend, I suspect that revenue will continue to grow at around this rate for quite some time.

The best thing about UPS is that it can be bought right now. According to data from FAST Graphs, shares of UPS have averaged 19.3x earnings over the last 10 years. As of right now, the shares trade at just 18.1x trailing earnings, a discount of just over 6%.

The company's shares also yield a nice dividend of 3.2%; over the last 10 years, UPS has averaged 7.5% dividend growth. I fully expect that trend to continue, as dividends are 75% of trailing 12-month cash flow, and that's with the heightened capital expenditure UPS has going right now.

For all these reasons, I recommend buying UPS, especially if you are an income investor. I think UPS will be a good source of dividend growth for years, and shares are at a meaningful discount right now.

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