United Parcel Service: Improving Economy Not Priced In

The US economy is on the mend and so it follows that companies that are economically sensitive should do better as 2007 progresses. Tuesday, Federal Express (FDX) voiced optimism concerning second half operations, and the market responded positively.

While we don’t follow Federal Express, United Parcel Service (UPS) is on our Buy List. UPS is the world’s largest integrated air and ground package delivery service, operating in over 200 countries. Domestic parcel delivery volume is expected to increase this year. Just as important is the fact that, international volume and pricing are improving in both Europe, and Asia.

Further gains are expected in Asia when the company brings a terminal in Shanghai on line which will allow the company to expand its intra-Asia business. The company recently completed major cost cutting measures in its supply chain management business which [a] will dramatically improve margins and [b] allow UPS to cross market it services. The company has grown its earnings and dividend in excess of a 15% pace since its founding; it has a 19-20% return on equity and a debt equity ratio of only 17%.

Of course, investors have to grit their teeth these days when investing in companies where fuel is an important cost factor - which at least partially accounts for UPS stock’s lagging performance. Certainly, UPS has more flexibility than the airlines in adding surcharges as jet fuel costs rise (sustaining margins), though non-international shippers can elect to ship via cheaper ground transportation if those surcharges become punitive (losing revenue). Our bottom line is that the stock price reflects the worry about higher fuel prices but not an improving economy nor the possibility that oil prices might actually decline.

Our Buy Range for this stock $66-73 a share. Our Stop Loss is $58 and we would take profits at $89.

EPS: 2006 $3.86, 2007 $4.15, 2008 $4.50
DVD: $1.68
YLD 2.4%

Disclosure: The author has a long position in UPS.

UPS 1-yr chart