United Parcel Service Inc. (UPS, Financial) has experienced a revenue reduction only once in the past 25 years. That occurred in 2008 and was a result of the economic slowdown that came with the Financial Crisis. Otherwise, its top line has moved upward every year. Since 1998, it has recorded average revenue growth of 5.20% per year. However, that's about to change as UPS guides for lower revenue in 2023.
Could this be the end of UPS' growth story? I don't think so. The future will be determined by UPS' capital allocation strategy, and the company definitely isn't slacking off in this respect.
Abut UPS
Founded in 1907, UPS delivered 24.3 million packages a day last year, according to its 10-K for 2022. Strategically, UPS focuses on the parts of its market that benefit from its end-to-end network, delivering packages all the way from the original shipper to the end receiver.
Its market includes individual homes as well as small- and medium-sized businesses, health care, international and some large enterprises. It operates through three segments: U.S. Domestic Package, International Package and Supply Chain Solutions. All its services are managed through a single, global smart logistics network.
Capital allocation
Long-term and consistent growth is only possible with good capital allocation. How a company distributes money among conflicting priorities will determine its financial success and its returns to shareholders.
UPS claims in its annual filing that it takes a disciplined and balanced approach to capital allocation. According to its fourth-quarter and full-year 2022 presentation, the company invested in capital expenditures, dividends and debt repayment.
It had cash flows from operations of $14.1 billion for the year. From that, it deducted CapEx of $4.8 billion and other investing activities of $380 million. That left free cash flow of $9.0 billion.
Of the $4.8 in CapEx, $1.7 billion went into buildings and facilities. Another $1.3 billion went into aircraft and $1.1 billion went into vehicles, while $723 million went into information technology.
These investments, or reinvestments, will drive growth in the longer term. The capital going into buildings, planes and trucks is self-explanatory. The investment in information technology is more interesting in an analytical sense. As noted above, it calls its logistical system a "global smart logistics network." UPS noted in its annual filing, “Our sophisticated engineering systems allow us to optimize network efficiency and asset utilization.” In other words, it likely can provide something along the lines of a continual improvement process for logistics.
That’s an important competitive advantage, and a way to continue growing earnings more quickly than revenue. Over the past three years, the company's revenue growth averaged 10.4% per year while earnings per share without non-recurring items grew by an average of 37.2%.
Shareholder returns
Dividends and share repurchases are also key ingredients of a capital allocation recipe. Altogether, UPS returned $8.6 billion to shareholders in 2022. That was made up of $3.5 billion in share buybacks and $5.1 billion in dividends.
In 2022, the company boosted its dividend by roughly 50%. In 2021, it paid shareholders $4.08 annually and in 2022, the dividend went up to $6.08. In the first quarter of 2023, it increased again to $6.48. As a result, UPS now yields 3.29%, which is nearly twice as much as the S&P 500 average in December.
It also appears the company is aiming to become a Dividend Aristocrat, which is a stock included on the S&P 500 that has increased its dividend every year for the past 25 years or more.
Over the past 10 years, UPS has reduced its share count by an average of 0.59% per year.
The dividend and share buybacks make it easier to raise new capital by issuing new shares. Capital from a new share issuance makes more funds available for investment in business growth without hurting the balance sheet.
UPS has also made debt reduction another key use of capital, which I count as a way to return value to shareholders:
After increasing its long-term debt substantially between 2014 and 2018, it made substantial reductions in 2021 and 2022. The repayments cut the debt load from $21.74 billion at the end of 2020 to $17.00 billion at the end of 2022.
The repayments also allowed the company to get back to its adjusted-debt-to-Ebitda ratio target of 1.4 to 1.5. The company's 2022 presentation noted that the ratio had been near 3.5 at the end of 2020.
Debt repayment reduces the amount of interest the company must pay, freeing up capital that can go to CapEx or to shareholder rewards. In addition, it makes the balance sheet more attractive to investors. Both effects help make capital available for later expansion.
Outlook
Looking forward to the remainder of this year, UPS expects revenue to fall back from over $100 billion in 2022 to something between $97 billion and $99.4 billion in 2023. As for the uses of capital in 2023, it plans CapEx of $5.3 billion, dividend payments of $5.4 billion and share repurchases of $3 billion (all are estimates, of course).
UPS may not be able to keep up the pace in the short term due to the struggling economy, but I don’t expect it to slow its growth in the long term. America’s biggest delivery company has a capital allocation strategy that should continue to please its shareholders in the years to come.
