UPS Stock Crashed By Amazon Contract? Is It A Buy Now?

$United Parcel Service Inc(UPS)$

The market is showing strong performance overall, with plenty of positive momentum, but there are also some struggling companies. United Parcel Service (UPS) is a major focus today, as it has dropped 15%, hitting a new 52-week low. Despite this, both Wall Street and Seeking Alpha maintain a "buy" rating for UPS, and its dividend yield has risen to around 5%. However, UPS has had a rough year, down 28%, and over the past 10 years, it has only gained 34%, significantly underperforming the S&P 500.

What Cause The Crashed And Risk Ahead

One of the primary reasons for UPS's sharp decline is its decision to reduce exposure to Amazon, its largest customer, which is expected to cut UPS's revenue. Volumes from Amazon are projected to drop by more than 50% over the next 18 months, a significant blow to UPS's forecast for 2025. This news surprised analysts, especially as UPS has already been grappling with weak demand post-pandemic and low profitability in its shipments. Amazon accounted for nearly 12% of UPS's revenue in 2023, and this reduction in volume is certainly a concerning sign.

UPS is trying to put a positive spin on the situation, suggesting that by carrying less freight for Amazon, their revenue per package could improve. However, fewer shipments still mean a decline in total sales. Looking ahead, UPS's 2025 revenue forecast is now $89 billion, down from the $95 billion analysts had anticipated. On the positive side, their margin has increased slightly, from 9.8% to 10.8%.

Earning Overview

Despite this, UPS has exceeded earnings expectations in four of the last five quarters, with a solid track record of beating EPS forecasts. However, analysts worry that the reduction in Amazon's business could severely impact future results. UPS's forward price-to-earnings ratio is relatively low at 15.31, and the company is trading below both its 5-year average and the sector average, indicating a significant discount.

Fundamental Analysis

Looking at the company's performance, UPS's growth rate is concerning, with a -3% year-over-year decrease, well below the sector median. Over the next 3 to 5 years, the EPS growth is expected to be just 4.61%, which is underwhelming compared to the sector and industry averages. On the positive side, UPS maintains an A+ gross margin, though it is still below the sector average. Cash flow from operations is strong at $9.2 billion, though it’s slightly lower than their 5-year average.

Free Cash Flow

Free Cash Flow (FCF) has been inconsistent over the last few years. In 2023, the company saw a drop in free cash flow relative to previous periods, which raised some concerns about its ability to sustainably cover its dividends and other obligations.

Free Cash Flow Payout Ratio: Ideally, this ratio should be below 60%, meaning that the company should generate enough cash flow to cover its dividend payments without relying too heavily on debt or external financing. However, for the last year, UPS’s ratio has been well above 60%, sometimes reaching into the triple digits, which is concerning because it suggests that UPS has been paying out more in dividends than it’s generating in cash flow.

Cash Flow Improvement Expectations: Despite recent inconsistencies, there's a forecasted increase in free cash flow over the next 12 months, which should help improve the company's ability to pay dividends and reduce any pressure on its financial position.

In summary, while UPS has faced challenges with free cash flow recently, it is expected to improve, and the company remains capable of generating strong cash flow from operations, which supports its dividend payments.

UPS has struggled compared to its peers in the air freight and logistics sector, with a 25% decline in the past year, and just a 16% gain over the last 5 years. The broader industry has faced similar challenges, with FedEx being one of the few standouts, up 97% over the past 5 years. While UPS’s performance is below par, it’s not the worst in the sector.

Guidance

Despite a strong Q4, where earnings exceeded expectations, the company lowered its full-year 2025 revenue and profit guidance due to a planned reduction in Amazon volumes. UPS is scaling back its relationship with Amazon, reducing its volume by over 50% by 2026. While Amazon is UPS’s largest customer, it’s not the most profitable, and UPS believes this move will allow for better returns. This shift caused a significant drop in UPS shares.

UPS aims to fill the gap left by Amazon’s reduced business by focusing on more profitable market segments, such as small and medium-sized businesses, healthcare logistics, and cold chain logistics. The company is also reconfiguring its network, closing 10% of its U.S. buildings and targeting $1 billion in cost savings. UPS plans to continue investing in these areas to grow margins.

Market Sentiment

Institutional ownership is around 60%, with about $8 billion in sales over the past year. In Q4, institutions sold significantly more than they bought, which reflects broader market trends. Insider transactions have shown some buying and selling, though most sales were relatively small, including a notable sale in November. While insider selling doesn’t necessarily indicate negative sentiment, it’s something to watch.

Dividend

UPS has a solid dividend score and a strong credit rating (A), which suggests the company is safe in terms of dividend payments. However, dividend growth has been poor, with just a 6% increase last year, below inflation, and the company’s growth projections appear modest at best for the near future. Despite this, UPS has a consistent dividend history, having increased its dividend for 14 consecutive years without cutting it.

With a dividend safety score of 69, UPS appears safe in terms of dividend sustainability. Now, before diving deeper into the evaluation, let me mention that we release a free weekly article every Monday. It covers severely undervalued stocks, market trends, and more. You can sign up and start reading immediately to get access to valuable stock insights.

Challenges

In summary, UPS’s current challenges—particularly its loss of Amazon business—have created uncertainty, but the company still offers a strong dividend yield and a solid credit rating. It’s currently undervalued compared to both the sector and its 5-year average, but its long-term growth prospects are in question, especially given the reduction in Amazon volumes and broader industry struggles.

Valuation

Let's begin with the first valuation model. Keep in mind that we don't rely on just one model, as we run through a thorough process. The blue tunnel indicates the expected fair price, and right now, the stock is trading below that level, suggesting it is significantly undervalued. However, we don't just focus on this single indicator.

Next, we look at the Dividend Yield Theory, which shows the company is undervalued. The current dividend yield is not only above the 5-year average of 3.48% but also at the highest level the company has offered over this period. Moving on to the forward P/E ratio, we see another undervaluation signal. At 13.2, it’s below the 5-year average, and as we mentioned earlier, UPS is trading at a steep discount compared to the sector.

Now, when we assess the free cash flow payout ratio, we want it to be below 60%. However, over the past year, it has been in the triple digits, which raises concerns. This means the company has paid out more in dividends than it has generated in free cash flow, a situation we'd rather not see. We typically prefer a consistent and rising free cash flow over the long term, but it's been inconsistent. On the bright side, we expect a substantial increase in free cash flow over the next 12 months.

For sales growth, we look for a consistent range of 3-7%. UPS has mostly met this target, but there are negative figures over the past year and on a trailing 12-month basis, likely influenced by the Amazon news. It's important to keep this in mind moving forward. However, UPS has been engaging in share buybacks, returning excess cash to investors, which is a positive sign.

Looking at Return on Invested Capital (ROIC), despite a decline over the last decade, it remains solid, at 20% in 2023 and 18% on a trailing 12-month basis. Moving on to margins, we want to see signs of improving operating efficiency, but the margins are fluctuating around the lower levels we want to see, showing little growth. The free cash flow margin is also not impressive. When it comes to net debt to EBITDA, we ideally want the ratio below 3. UPS stands at 1.58 in 2023, which is healthy. We also look at the number of years it would take the company to pay off its debt with its current cash on hand, and while it’s not a major concern, it’s worth monitoring.

Moving on to the intrinsic value of UPS, our calculation gives us an average of $130, derived from three models. First, the multiples valuation compares UPS to similar companies in its sector. We use the average P/E ratio, multiplied by UPS’s EPS, and this gives us an undervaluation signal. Next, the Dividend Discount Model, factoring in recent dividend increases (under 1%), uses a 3% growth assumption for the future, which also signals undervaluation. Lastly, the Discounted Cash Flow (DCF) model assumes a growth rate of 6%, and with the appropriate discount rate, this gives us a present value of future cash flows, yielding an intrinsic price of $127. All three models indicate slight undervaluation.

We don’t stop there; we apply a margin of safety (MOS) of 10% to our intrinsic value calculation. This gives us a range of approximately $117 for the MOS price. Right now, we see a 10-15% margin of safety, which means UPS could still be undervalued, but not by a massive amount.

Wall Street’s prior price target was $145, implying a 27% upside. However, given the recent news, it's likely that they will revise their price target downward. We believe the impact of the Amazon news will significantly affect UPS's numbers going forward. Therefore, while the 5% yield may be attractive, the margin of safety isn’t compelling enough to consider a buy at the moment.

What are your thoughts? Are you looking to buy or sell? Let us know in the comments.

Disclaimer: I want to make it clear that I am not a financial advisor, and nothing I say is intended to be a recommendation to buy or sell any financial instrument. Additionally, it's important to remember that there are no guarantees or certainties in trading or investing, and you should never invest money that you can't afford to lose.

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