Prediction: UPS Stock Will Outperform If Management Cuts the Dividend

It could be a third time unlucky for UPS (NYSE: UPS) in 2025. Having failed to meet its initial full-year guidance in 2023, and then again in 2024, UPS is under real pressure to avoid doing so this year due to the slowdown in the economy. There's a strong case for buying the stock, but it would be even stronger if management decided to cut the dividend.

The dividend is not well covered under the best of assumptions

Investors should be wary when a blue-chip stock like UPS yields almost 7%. The market is hinting that the dividend isn't sustainable, and for good reason.

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The dividend was questionable even before the tariff conflict started, hurting trade flows, corporate and consumer confidence, and, in turn, delivery volumes. For example, in January, management told investors it planned to pay $5.5 billion in dividends and buy back $1 billion in shares, even as it forecast just $5.7 billion in free cash flow (FCF) for the full year.

To be fair, management uses earnings, not FCF, to calculate its targeted dividend payout ratio of 50%. Still, those who prefer cash flow (after all, dividends are paid out of cash) will be concerned that nearly all the estimated FCF in 2025 will go toward dividends.

Full-year assumptions under threat

When asked about its capital allocation plans for 2025 on the earnings call, CEO Carol Tome replied that she's talked with CFO Brian Dykes about debt financing the buybacks "because with the yield on the stock and the after-tax cost of the debt, it's a really good trade." In other words, she's contemplating borrowing money to buy back stock because the interest payment on the stock is lower than the dividend per share that must be paid out on it.

Image source: Getty Images.

At this point, investors must be wondering if merely cutting the dividend isn't a better idea, not least because debt financing could be used for areas that operationally create value for shareholders, like mergers and acquisitions or investment in the business.

That question is even more apposite considering that full-year assumptions are under threat now. For example, management declined to update investors on its full-year guidance on the earnings call, and what Dykes said about the second quarter is ominous:

• U.S. domestic package average daily volume will decline by 9% year over year, following a 3.5% decline in the first quarter
• U.S. domestic package revenue will decline by a low-single-digit percentage
• "SMBs [small and medium-size businesses] will be disproportionately impacted by the uncertain environment, which will add some pressure to operating margin."
• International revenue will decline by about 2%

A lot of the decline comes from the decision to reduce less profitable or loss-making Amazon deliveries (management plans to lower Amazon volume by 50% from the start of 2025 to the middle of 2026) to focus on more profitable deliveries and boost margin. The fact that Dykes said U.S. domestic package margin would only expand by 30 basis points (where 100 bass points equals 1%) is also a concern, as is the softness in SMBs -- a target market for UPS.

Simply put, UPS' full-year guidance and expectations for $5.7 billion in FCF in 2025 are seriously threatened.

Image source: Getty Images.

Long-term growth

The mathematics of its dividend aside, UPS is on a track to long-term earnings growth. Although there's little management can do about the trade conflict, its game plan makes sense, and there are real signs of operational improvement.

Reducing low- and no-profit Amazon deliveries makes perfect sense. It allows management to cut costs and reshape its network to better suit higher-margin activity. Indeed, management expects to take out $3.5 billion in expenses this year. Moreover, UPS continues to invest and grow its exposure to targeted markets like SMBs and healthcare.

Meanwhile, its ongoing investment in technology (smart facilities and automation) will increase facility productivity, allowing it to close less-productive facilities.

Image source: Getty Images.

Why cutting the dividend makes sense

UPS has a good long-term story. It creates a good value opportunity for investors looking to buy stocks on a dip and anticipating a successful resolution to the trade conflict. However, that narrative may be crowded out by the simple mathematics around its dividend, and management may need to bite the bullet and cut it while UPS rides out a difficult period.

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John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Lee Samaha has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Amazon. The Motley Fool recommends United Parcel Service. The Motley Fool has a disclosure policy.