Earlier this year, I wrote an article entitled "UPS: Worth The Premium" where I outlined four reasons why UPS (NYSE:UPS) was a strong buy into 2012 and 2013. These reasons ranged from the company's strong earnings, its past track record, its ultimate opportunity to gain on the heels of the U.S. Postal Service's decline, to its strong dividend. The landscape has changed, though, in the wake of the global difficulties that face shippers like UPS and FedEx (NYSE:FDX) in the current economic environment. Last quarter, UPS reported softer than expected earnings and the company's CEO & Chairman Scott Davis stated:
Increasing uncertainty in the United States, continuing weakness in Asia exports and the debt crisis in Europe are impacting projections of economic expansion. Throughout its history, UPS has maintained its strength in all economic cycles and we are making the adjustments necessary to respond to today's challenging conditions.
These results have turned the company's stock performance negative for the past quarter due to this apparent softening in the company's business. The question now becomes whether UPS is still a strong buy in this uncertain economy. The answer lies in whether or not the company can continue to drive costs out of its system and continue to innovate. The long term time horizon for UPS looks strong due to its past discipline and ability to achieve logistical excellence. The issue is whether in the short term the company can deliver profits that will not send its stock plummeting.
The current issue for investors is the company's valuation. In uncertain times when earnings are likely to disappoint, the room for losses increase greatly when a stock is looked to be overvalued. The following illustrates UPS's financial/valuation position as compared to FedEx:
Forward Price/Earnings: 14.09
- FDX: 10.31
PEG Ratio: 1.47
- FDX: .85
- FDX: 4.95
Profit Margin: 7.2%
- FDX: 4.76%
Return on Equity: 48.37%
- FXD: 13.57%
- FDX: .60%
Strong Financials, but High Valuation:
These results show a clear distinction between FDX and UPS in two key ways. The first is that on a valuation perspective, FDX is much cheaper. On the other hand, UPS shows much stronger financial metrics with both its profit margin and return on equity being higher. This represents a hard dilemma for investors in beginning the question of whether UPS is worth the high premium over its counterpart FDX. The evidence for suggesting that UPS is a stronger buy into the long term is that the company has consistently innovated and maintained strong financial results on the heels of a consistent business model. This being said, in the short term the stock could drop due to declining profits in this difficult global economy.
UPS's dividend is extremely strong for a company of its size. It offers another level of differentiation from FDX from an investment perspective. It also shows the company's commitment to rewarding investors. This, coupled with its financial performance, brings the valuation into greater clarity in showing that UPS is a stronger company and is worth a premium. The question is to what extent (if any) is UPS overvalued.
For investors, perhaps the best advice is to wait for UPS to report earnings and to decide whether the stock's valuation is enough of a shortcoming to detract from its overall offering. In the long term, UPS is on a trajectory to achieve through its commitment to driving costs out of the system and augmenting its business through the decline of the US Postal Service. In the short term, though, investors need to be cautious as to whether UPS will decline in market cap due to its valuation. More time is needed to fully assess the situation.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.