Prediction: UPS Stock Will Outperform If Management Cuts the Dividend
UPS could miss its initial full-year guidance for the third year in a row.
End-market weakness and the deteriorating sustainability of the dividend cloud UPS's underlying progress on its long-term strategic objectives.
Management doesn't want to cut the dividend, but it might be in the best interest of shareholders and the stock price.
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:
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