This Just In: Upgrades and Downgrades
At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." Today, we'll show you whether those bigwigs actually know what they're talking about. To help, we've enlisted Motley Fool CAPS to track the long-term performance of Wall Street's best and worst.
Never mind what "Brown" can do for you ...
... because what UPS (NYS: UPS) shareholders should really be thinking about this week is what an upgrade from Raymond James can do for their UPS stock. Last week, a big upgrade from RJ wasn't enough to overcome the disappointment of seeing UPS miss earnings by $0.01. (A whole penny? Horrors!) Despite growing sales 4.4% year over year, and improving its earnings at more than twice that rate, investors took one look at the words "earnings miss" and decided to sell the stock, which closed down 2.3% for the week in a generally rising market.
RJ thinks this was a mistake. That far from being a "sell," UPS is actually an even better bargain than it looked pre-earnings. So not only did the analyst up its rating on UPS to "strong buy," but it also tacked on $10 to its price target -- now $95 a share.
Now here's the real shocker: I think Raymond James is right. And all the investors who sold UPS last week? They're dead wrong.
The case for UPS
UPS may have "missed estimates" last week, but Wall Street's guessing game notwithstanding, the company actually performed pretty well. Operating margins improved by 20 basis points, helping to improve the profitability of UPS's 4.4% added revenues. Management stuck with its full-year guidance of $4.75 to $5 per share for fiscal 2012. This suggests 9% to 15% earnings growth, right in line with the 12.8% growth rate that Wall Street expects UPS to produce over the next five years.
Now, that may not sound like much for a stock that costs more than 20 times earnings today. But consider: Over the past 12 months, UPS has generated $5.9 billion in free cash flow. That's more than 50% -- or $2 billion -- better than the $3.9 billion it was allowed to claim as "net income" under GAAP. In other words, this company that so many investors are looking at as a "20 P/E stock" is actually selling for less than 13 times annual free cash flow.
When you compare this valuation to UPS's near-13% growth rate -- and factor in the 2.9% dividend yield -- UPS doesn't look expensive at all. The more so when you compare it to FedEx (NYS: FDX) , which appears to cost just 14 times earnings, but which generated less than $1 billion (and less than half of its reported net income) in actual free cash flow last year.
And UPS could be even cheaper than that. In recent weeks, we've seen earnings reports from both eBay (NAS: EBAY) and Amazon.com (NAS: AMZN) confirm the strong growth in domestic parcel delivery. Last quarter, eBay reported a whopping 29% spike in quarterly sales. Amazon did even better -- 35% growth.
UPS plays a big part in this shift to online shopping. And UPS is laying the groundwork for even stronger growth abroad. Consider that while strong online sales in the U.S. contributed to 3.8% growth in average daily shipping volume for UPS in the U.S., overseas, the average volume growth of exports grew 5.4%. And while UPS doesn't break down who exactly is doing all this shipping overseas, it stands to reason that at least part of the explanation for UPS's overseas strength is its alliance with China's AliExpress, part of the Alibaba Group that Yahoo! owns a stake in.
When this alliance was first announced in 2010, I argued that it was good news for all parties involved -- all the different corporate levels of Alibaba and its owners -- but that it marked an especially "big win for UPS in its struggle with FedEx for global market share." We'll get our next update on how this rivalry is playing out when FedEx reports its own Q4 earnings in June. For now, though, I think it's enough to say that the alliance is working out nicely for UPS and supports Wall Street's generally bullish stance on the company's growth prospects.
Thirteen times free cash flow is not a high price to pay for 13% long-term profits growth. Raymond James' upgrade shows us that Wall Street is starting to catch onto this fact. But the price is cheap enough today that you still have time to profit from the stock's run-up. Add in the fact that UPS will pay you a 2.9% dividend while you wait for the run-up to materialize, and UPS is just what Raymond James says it is: a strong buy.
In fact, I'm so certain of this that I'll stake my reputation on it. Right now, I'm heading over to Motley Fool CAPS to publicly rate UPS an "outperform."
Think I'm wrong? Follow along.
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At the time this article was published Fool contributorRich Smithowns no shares of, nor is he short, any company mentioned above. He does, however, have public recommendations available on more than 50 separate companies. Check them out on Motley Fool CAPS, where he goes by the handleTMFDitty-- and is currently ranked No. 349 out of more than 180,000 CAPS members. The Motley Fool has adisclosure policy. The Motley Fool owns shares of Yahoo! and Amazon.com.Motley Fool newsletter serviceshave recommended buying shares of FedEx, eBay, Amazon.com, and Yahoo! and writing puts on eBay. We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors.
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