UPS: Tempering Our Margin Forecast and Questioning the Dividend

Key Morningstar Metrics for United Parcel Service

• Fair Value Estimate: $113.00
• Morningstar Rating: ★★★★
• Morningstar Economic Moat Rating: Wide
• Morningstar Uncertainty Rating: High

We are tempering our medium-term margin assumptions for UPS UPS as we take a more conservative stance, especially due to unfavorable mix. In FedEx’s FDX fiscal first quarter, the impact of plummeting China-to-US volumes had more of an impact than we expected, and we look for a similar outcome for UPS.

Why it matters: Tariff action and the end of the US de minimis exemption are driving down higher-margin China-to-US international package volumes. We now assume unfavorable mix has a longer lasting profitability impact.

• We also suspect the convoluted global trade backdrop will boost customs-clearance costs, creating another cost headwind for the international division.
• Since the de minimis provision was used by many higher-margin small-business customers, we are baking in more of a maintained mix impact for the US domestic segment, as well. The domestic operations are also grappling with lower-than-expected driver attrition.

The bottom line: Our margin adjustments reduce our DCF-derived fair value estimate for wide-moat UPS to $113 per share from $118.

• Uncertainty is elevated, but we still see long-term upside opportunity to UPS’ shares as it gradually gains traction rationalizing network capacity in accordance with Amazon-related volume declines, and amid an eventual recovery in business-to-business package volumes.

Between the lines: A word of caution regarding UPS’ dividend. In 2022, UPS boosted its dividend by almost 50%, and it will approximate $5.5 billion in 2025. When including debt added this year, our base-case free cash flow forecasts suggest the dividend is doable in the years ahead, but it will be tight.

• While UPS’ balance sheet is healthy and the firm could probably make the current dividend work, we would not be surprised if the board eventually cuts it to be more in line with UPS’ targeted 50% payout ratio.
• All else equal, a cut wouldn’t directly impact our fair value estimate, but it could create short-term share price volatility if the shareholder base adjusts.