UPS Is Investing in AI and Driving Margin Growth, So Why Is the High-Yield Dividend Stock Selling Off?

United Parcel Service‘s (UPS 0.88%) stock price fell over 8% on March 26 as the market reacted negatively to the company’s 2024 Investor and Analyst Day.

The market didn’t seem to be paying much attention to the part of the presentation that focused on how UPS embraces artificial intelligence (AI), automation, and machine learning to drive margin growth. It glossed over the report that UPS’ Velocity facility in Kentucky has over 700 robots and can process over 350,000 packages per day. It didn’t seem impressed that the company is automating and consolidating hubs across key regions like New York, Massachusetts, Texas, and more. The efforts outlined should drive efficiency and lead to margin growth.

The market just wasn’t impressed by the company’s technological advancements. Instead, it put all its focus on some delivery data that went a long way to explaining why UPS’ stock price is now hovering within 10% of a three-year low.

Image source: Getty Images.

An unexpected demand slowdown

The package delivery industry does best when supply exceeds demand (with a small buffer). During the pandemic’s height in 2020 and early 2021, demand outpaced supply, leading to a shortfall and rising margins for package delivery companies.

The expectation was that the COVID-19-related spike in e-commerce would sustain momentum, but it didn’t. In fact, there is now a 12 million average delivery volume (ADV) surplus of U.S. small delivery packages, compared to the 6 million ADV surplus pre-pandemic. The surplus compressed margins, hurt profitability, and threw a wrench in growth projections.

Here’s a look at UPS’ internal projections for U.S. small package ADV.

  Projected ADV Actual ADV
FY 2019 (as of January 2021) 58 million 59 million
FY 2020 (as of January 2021) 74 million 77 million
FY 2021 (as of January 2021) 86 million 83 million
FY 2022 (as of January 2021) 97 million 83 million
FY 2023 (as of January 2021) 108 million 84 million
FY 2024 (as of February 2024) 88 million
FY 2025 (as of February 2024) 93 million
FY 2026 (as of February 2024) 98 million

Data source: UPS Internal Analysis. ADV = Average delivery volume. FY = Fiscal year.

The company’s projections as of January 2021 forecasted a 13.4% compound annual growth rate (CAGR) through 2024. But what actually happened was a mere 3.1% CAGR, resulting in a 23% difference between 2023 results and initial expectations.

The company’s revised estimates (shared in the March 26 presentation) call for a 5.5% CAGR from 2024 through 2026, which seems more reasonable. UPS expects a return to growth in the small package delivery industry. The issue is that 2026 ADV estimates are now 98 million, which is a meaningful improvement from 2023 but is around the same as what UPS initially estimated for 2022.

UPS was way too optimistic about growth in one of its key markets. It blamed inflation and geopolitical tensions that disrupted global trade. Whatever the root cause, UPS overexpanded capacity and is now paying the price with its margins. Its solution is to slow investment and let demand catch up with supply. In the meantime, there will be short-term pain as UPS backpedals.

A path to increased profitability

UPS announced several goals during its investor and analyst presentation, including becoming the premium small package provider, achieving 40% of U.S. small and medium-sized business volume, and becoming the No. 1 premium international small package provider. Its 1+2 plan allows for 2024 to be focused on volume and adjusted operating profit growth, with 2025 and 2026 focused on volume and adjusted operating profit margin growth.

In the presentation, UPS mentioned that its teamsters’ contract is front-loaded, meaning there will be higher costs in 2024 that will weigh on profitability. However, the 1-year anniversary of the contract occurs on Aug. 1. After that, costs will go down and set the stage for profitability improvements.

When the turnaround is all said and done, UPS expects 2026 revenue of $108 billion to $114 billion and an adjusted operating margin of at least 13%.

UPS needs time, but it will pay investors to wait

UPS is headed in the right direction, but it will take time. The good news is that the company has reset expectations and can achieve its guidance even with moderate growth.

The stock will likely remain pressured in the short term. 2024 is shaping up to be a challenging year. That’s disappointing, considering 2023 was a terrible year in which UPS missed its guidance, and the full magnitude of the slowdown became apparent.

Long-term investors want clarity about where a business is headed, not where it has been. UPS provided that in this investor update. The market may overlook the company’s long-term investments in AI and automation and focus more on profitability improvements. But it’s worth paying attention to the results of these investments and whether they can continue driving higher delivery volume and efficiency.

In the meantime, UPS has a 4.5% dividend yield and 15 consecutive years of dividend increases. That’s a sizable incentive to stay patient and give the company time to turn around.


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