UPS: The Market May Be Ahead of the Analysts

Investopedia Advisor submits: Sometimes a stock that is almost unanimously regarded as a great long-term investment can take one on the chin and go straight to the canvas with a resounding thud. That’s exactly what happened to United Parcel Service (UPS) back at the end of July when it reported its second quarter results.

Despite reporting a 10% increase in earnings per share on a 15% improvement in revenues, the shares went into freefall, dropping nearly 14% intraday before closing with a loss of just over 10% on the day of the announcement. As is usually the case in these situations, the catalyst for the price drop was the company missing analyst expectations by a narrow margin. Since then, the shares have struggled, unable to recover the lost ground. Is UPS down for the count, or are investors over-reacting to the earnings miss?

Over the last few years, a strong U.S. domestic economy and rapid growth in global trade has led to a significant increase in demand for small package freight delivery services like those offered by UPS and its chief competitor Federal Express (FDX). Judging by UPS’s latest numbers, so far there’s no sign of any let-up in this trend.

For the second quarter, U.S. package volumes, which account for 67% of UPS’s revenues, were up 4.7%, while international freight (19% of revenues and growing) rose an impressive 16.5%. In addition to volume growth, the pricing trend remained healthy, which is up 2.7% per package on a consolidated basis.

Earlier this year, UPS had increased air and ground freight prices by 5.5% and 3.9% respectively. The continued volume growth so far this year suggests that the company’s customers took the price increases in stride.

Despite the good news, management did raise some warning flags, indicating it now expects slowing economic growth and rising fuel costs to dampen growth this year. Earnings growth this year is now forecasted to decelerate to the lower end of the 11%-16% range previously offered as guidance.

Of course, the macro-economic evidence continues to roll in suggesting the U.S. economy could be headed towards something a tad more challenging than a growth slowdown later this year and on into 2007. It’s likely that a cyclical stock like UPS would see an earnings slowdown somewhat worse than management is prepared to concede at this point. That could lead to further price declines of more than what we’ve seen to date.

Since hitting a 52-week high of just over US $83 last May, UPS shares have lost about 15% - a relatively better performance than the 17% decline by FedEx from its recent peak. However, looking back at early 2005, when similar growth slowdown fears prompted a one-day gap induced sell-off in UPS shares, the total damage done over the ensuing months came to a 23% loss.

If you take this little example from the past and put in the context of the present, adding such facts as significantly higher fuel costs, and much higher probability of a real recession in the offing, you’d want the shares to move somewhat lower before considering them a buy. If you did so, you’d be on the contrarian side of the fence, as the consensus view already sees the shares as a buy at current levels. Based on consensus EPS forecasts of US $4.27 for 2007, the shares are now trading at just 16.5x forward earnings – well below the 19x-31x range over the last five years.

But, dare I say it, analysts have at times been known to revise their estimates downward with a considerable lag. The market may just be ahead of the analysts on this one.

UPS 1-year chart:

By Eugene Bukoveczky, Contributor - Investopedia Advisor

At the time of release Eugene Bukoveczky did not own any shares in any of the companies mentioned in this article.