With the ongoing growth in e-commerce, the logistics industry continues to enjoy a promising growth outlook. In this article, we are going to take a look at the two dominant U.S. logistics giants that also happen to pay sustainable and growing dividends.
No. 1: United Parcel Service Inc.
UPS (UPS) provides logistics and package delivery services, such as transportation, distribution, ground freight, ocean freight, insurance, and financing. The company's operations are divided into three segments: U.S. Domestic Package, International Package, and Supply Chain & Freight.
UPS is the largest logistics and package delivery company in the U.S., with its only major competitor being FedEx FDX. Despite economic headwinds, the company's dominant position in the industry allows for continued growth as online shopping increases. Thus far, there has been no manifest interest in a price war among the big players, and volumes could continue to rise even if base pricing increases. Therefore, competitive pressures are expected to remain relatively low in the sector.
The Covid pandemic did not significantly impact UPS, but a prolonged recession with reduced economic activity could have negative effects. For example, during the Great Financial Crisis, UPS saw a decline in its profitability with earnings-per-share dropping from $4.11 in 2007 to $2.31 in 2009. However, since then, profits have consistently increased. From 2007-2020, earnings per share grew by an annual rate of 5.5%. In the past nine and five years, EPS has risen by 12.2% and 10.%, respectively.
Moreover, UPS managed to maintain its dividend through the Great Financial Crisis, though the payout ratio rose due to a decline in net profits. The payout ratio has since stabilized to around 50% of earnings, which is sustainable. A dividend cut is unlikely but not impossible during a severe recession.
Thanks to its strong competitive positioning and prudent capital allocation policies, UPS has raised its dividend for 14 consecutive years, with a current payout ratio of around 50% due to strong earnings growth during and after the pandemic. A dividend cut is unlikely but possible during a steep and prolonged recession.
UPS reported fourth-quarter revenue of $27 billion, a 2.7% year-over-year decrease. The domestic segment had a 3.1% revenue gain, while the international and supply chain solutions businesses saw revenue decreases of 8.3% and 18.1%, respectively. Full-year revenue rose 3.1% to $100.3 billion and adjusted EPS was $12.94, up 6.7% year over year.
The 2023 outlook includes anticipated revenue between $97.0 billion to $99.4 billion, adjusted operating margin of 12.8% to 13.6%, capital expenditure of $5.3 billion, $5.4 billion in dividend payments, and $3 billion in share repurchases.
UPS has experienced several tailwinds in recent years, including e-commerce growth leading to an increase in the number of packages transported across the country. A strong economy has also driven demand for UPS services from businesses and consumers with higher disposable incomes. Online shopping is expected to continue outpacing brick-and-mortar growth, which should benefit UPS. Despite the Covid-19 pandemic, UPS had impressive results in 2020, and even more so in 2021 and 2022. Long-term tailwinds are intact, with the Covid-19 outbreak speeding up the trend towards online shopping and therefore greater demand for UPS' services.
Over the next half decade we expect UPS to grow earnings per share at a 4.5% CAGR. When combined with an expected 1.9% headwind from valuation multiple contraction and the 3.4% dividend yield, we expect 6% annualized total returns over the next half decade. Hence, we rate UPS as a "Hold."
No. 2: FedEx Corporation
Founded in 1971, FedEx (FDX) is a company that specializes in transportation and shipping services. Its range of offerings includes transportation, e-commerce, and business services. FedEx is organized into four main segments, namely FedEx Express, FedEx Ground, FedEx Freight, and FedEx Services. The company provides both domestic and international shipping services for package delivery and freight. In addition, FedEx offers a wide range of services such as sales, marketing, information technology, communications, customer service, technical support, billing, and collection services.
FedEx is among the Top 3 U.S. carriers for small-parcel delivery, along with UPS and DHL Express. It is also the biggest U.S. less-than-truckload carrier, which helps it develop strong relationships with retail and industrial shippers. While UPS has an edge in density and margins, FedEx has been gradually improving its ground position by investing in capacity and leveraging its speed advantage.
The surge in e-commerce during the pandemic has boosted profitability for FedEx's ground, express, and freight operations, but labor constraints, wage inflation, and volume normalization are expected to impact revenue and earnings before interest and taxes margins. Despite Amazon's (AMZN) increasing in-sourcing of last-mile deliveries, FedEx is still in a strong position to cater to other retailers venturing into e-commerce and maintain its established business-to-business relationships.
FedEx's competitive advantages stem from its flagship express and ground package delivery operations, which enjoy cost and efficient scale superiority over competitors. Moreover, this competitive advantage is quite sustainable given that it is unlikely that any other company will try to replicate a truly global parcel shipping network due to the immense financial losses and fixed costs associated with it.
FedEx's recently reported third-quarter results showed a 6.2% decline in revenues to $22.2 billion, largely due to weak demand, particularly at FedEx Express. The operating income was also affected by global inflation and came in at $1.04 billion, lower than the previous year, with the operating margin slipping to 4.7%. But the company is optimistic about its cost and efficiency initiatives and has raised its adjusted earnings-per-share guidance for fiscal 2023 to be between $14.60 and $15.20, which reflects management's confidence in improved profitability moving forward.
Overall, FedEx is a fairly low risk investment with strong business and management quality, robust and sustainable profitability, and a solid balance sheet. It generates sufficient cash flow to meet its debt obligations, invest in growth, and provide returns to shareholders. As a result of the duopolistic nature of the sector, with FedEx and UPS being the dominant players, the company has a strong moat and the potential for significant economies of scale. Its logistics expertise and vast network have made it one of the most reliable transportation providers in the world. Despite being considered recession-prone, Covid-19 highlighted the importance of its operations, and its low dividend payout ratio suggests that the dividend is unlikely to be cut even in severe situations.
Given that we forecast 6% annualized earnings per share growth over the next five years, no meaningful change in the valuation multiple, and the company's current 2.1% dividend yield, we expect the company to generate ~8% annualized total returns over the next half decade. This makes it a "Hold," but a "Buy" on dips.
Our Call
Competitively positioned logistics giants like UPS and FDX will likely continue to generate steady long-term earnings per share and dividend per share growth. While neither is priced particularly attractively at the moment, FDX appears to offer slightly better total return potential at the moment. If investors can patiently wait for a dip in the stock price of these world-class logistics businesses before buying shares, they can lock in a high probability of generating outsized risk-adjusted long-term returns.
(AMZN and UPS are among the holdings in the Action Alerts PLUS member club. Want to be alerted before AAP buys or sells these and other stocks? Learn more now.)
