By Matt Doiron
Last week UPS reported increases in revenue, operating income, and earnings per share compared with the second quarter of 2011. The company reduced its earnings guidance to $4.50 to $4.70 per share, which still represents a mid-single digit increase over its 2011 numbers and, at the middle of that range at $4.60 per share, would imply a current market capitalization of 16.6 times earnings. Perhaps surprisingly, UPS is not overexposed to the U.S. economy, with a beta of 1. Statistically, it is expected to fluctuate as much as the overall market. We covered UPS's P/E ratio with respect to the company's earnings guidance for 2012; on a forward basis, using analyst estimates for 2013, the P/E falls to 14.5. If UPS is expected to continue to deliver growth, then it begins to look like a cheap stock, particularly given its market leadership position, strong brand, and successful cash flow: in the first half of 2012, free cash flow was $3 billion.
UPS has a variety of strategies that it uses to spend the cash that its business generates. It currently holds $7.3 billion in cash as it attempts to close an acquisition of TNT Express, a worldwide logistics company; the acquisition is likely to be delayed as the European Commission reviews the transaction. UPS has used additional cash in the past year to pay out about $2 billion to investors- about $900 million in executed share buybacks and dividends to the tune of a 3% dividend yield. Perhaps UPS will use its future cash generation to engage in more acquisitions, but we think that it will at the least continue its historical pattern of dividend increases and perhaps use more of its cash to buy back stock.
Edgar Wachenheim's Greenhaven Associates is a fan of transportation and logistics: its top stock holding according to 13F filings is Fedex (FDX) but the fund also owns 3.9 million shares of UPS (find other stock picks from Greenhaven Associates). Warren Buffett's Berkshire Hathaway owned 1.4 million shares of UPS at the end of March; it does not seem to have touched this position in over a year. Renaissance Technologies had owned a very small number of shares at the beginning of the year but had increased its holdings to 1 million shares by the end of the first quarter (see the rest of Renaissance Technologies' portfolio).
Earlier this year two insiders at UPS sold a number of Class B shares at a price similar to the current price per a 10b5-1 trading plan. Insider selling is not a strong an indicator as insider buying because insiders may sell for a number of reasons, including to diversify their investments away from the company that employs them and avoid a potential double hit to their portfolio and their paycheck. Still, investors may want to keep these transactions in mind as they evaluate UPS further.
Fedex is UPS's closest peer. It pays substantially lower dividends for a company in the same industry (0.6% dividend yield) but trades more cheaply at a forward P/E of 10.5. FedEx, however, has a higher beta than UPS at 1.5 and has less than half the market capitalization, so would appear to be a riskier stock in the case of an economic slowdown. So far this year, Fedex and the S&P 500 have tended to track each other closely while UPS has somewhat underperformed. We think that if an investor is not worried about macro conditions and leans more toward value investing than income investing they should pick FedEx; an investor who does care about exposure to the U.S. economy or dividend checks should pick UPS. Two other logistics providers are Expeditors International (EXPD) and C.H. Robinson (CHRW). C.H. Robinson has seen growth similar to UPS's but trades at higher P/E multiples, while Expeditors also trades at higher multiples and has seen its business decline recently compared to a year ago. In addition, both of these companies pay lower dividend yields than UPS. We think they are not as good buys as UPS or Fedex.