The 1 Thing You Need to Know Before Buying UPS Stock

Source The Motley Fool

There are only a couple of weeks left before the end of the first quarter, so it's time to consider whether UPS (NYSE: UPS) stock is a buy before the company issues its earnings results on April 29. It's likely to be an eventful quarter for the company that could make or break the investment thesis for the stock. Here's what you need to know before investing in UPS.

Near-term weakness in the economy

There's no point tiptoeing around the elephant in the room: Package delivery is a cyclical activity. When the economy catches a cold, UPS sneezes, and when it returns to full health, UPS glows. Unfortunately, several management teams at industrial and transportation companies have discussed feeling some near-term weakness.

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Delta Air Lines recently cut its first-quarter revenue guidance to about 4% from a 7%-to-9% range previously. United Airlines management recently told investors it expected earnings at the low end of its guidance range with a notable drop-off in government bookings in the quarter. Industrial company 3M's CEO, Bill Brown, told investors there had been a push-out of sales starting in March. Semiconductor test technology company Teradyne's management cut its full-year guidance on the back of order push-outs and customers taking a cautious approach and reviewing capital spending options.

Why it matters to UPS

It means a lot to UPS because package delivery is not only a cyclical activity, it's also a relatively short cycle business. That means the window between changes in demand and sales is quite small. Package delivery is short cycle and so are airline bookings, and semiconductor companies are notorious for cutting capital spending on a dime. Meanwhile, 3M's Brown specifically said the push-outs are "certainly in the shorter cycle parts of our business."

It's hard not to imagine these developments are a consequence of tariff actions imposed on the economy, and UPS investors should expect some weakness in small package deliveries.

Two workers load cardboard delivery boxes into a van.

Image source: Getty Images.

UPS doesn't have much wiggle room

It's mainly a concern for UPS because its full-year guidance doesn't give much room for error. Going back to the last earnings call in January, UPS management's full-year guidance called for revenue of $89 billion and an adjusted operating margin of about 10.8%, implying about $9.6 billion in adjusted operating profit, which drops down into free cash flow (FCF) of "approximately $5.7 billion, including our annual pension contribution of $1.4 billion."

However, its dividend will cost $5.5 billion, and management plans to invest $1 billion in share buybacks. As such, the intended FCF doesn't fully cover its capital return aims (dividend and share buyback equaling $6.5 billion) and definitely won't cover it if UPS has to lower its full-year guidance. Indeed, management has discussed debt financing the share buyback.

Management's stated aim is to pay 50% of its earnings in dividends, but with the market penciling in $7.87 in earnings per share for 2025, a dividend per share of $6.56 represents 83% of earnings by these calculations. Adding back the $1.4 billion noncash pension expense brings the payout ratio to 69%, but it's still high, and the intended FCF barely covers the dividend.

A person bites their lip and looks unsure.

Image source: Getty Images.

Moreover, any significant weakness in the small package delivery market could disrupt at a time when UPS is intentionally reducing its level of Amazon deliveries. The plan is to lower Amazon delivery volume by 50% by the second half of 2026.

What it means for investors

There's no guarantee that UPS will be negatively affected, and the weakness that others are seeing could turn out to be temporary, not least if the tariff situation is clarified. As for the long term, it's unlikely to detract from the fundamental attractiveness of investing in UPS, which includes management's ongoing journey to improve profit margins by forgoing low-margin deliveries and growing its higher-growth deliveries (notably in healthcare and small and medium-sized businesses) while investing in productivity-enhancing technology (automation, smart facilities, etc.).

These are the key reasons to buy the stock, and they will remain even if UPS decides to cut the dividend (something management previously committed not to do) or walk back its share buyback aims in 2025.

The bottom line is to buy UPS for its long-term growth prospects but not purely for its dividends because, if the current economic pressure lasts, management may need to address its dividend/buyback aims.

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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 3M and Amazon. The Motley Fool recommends Delta Air Lines, Teradyne, and United Parcel Service. The Motley Fool has a disclosure policy.

Disclaimer: For information purposes only. Past performance is not indicative of future results.
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