2 Transportation Stocks to Pass
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Given the poor economic climate, it is natural that transportation would fall whether that be for vacations and business trips or mailing. This reason, when combined with the fundamentals, put UPS (NYSE: UPS) and Southwest Airlines (NYSE: LUV) on the "don't buy" list. Below, I review the fundamentals of the two companies.
UPS
This mail carrier trades at a respective 18x and 13.9x past and forward earnings with a dividend yield of 3.1%. The beta on the stock is 0.86, which means that it has lower volatility than the broader market. With multiples high already, it is thus unlikely to advance any further from the momentum of a recovery. Moreover, growth is not enough to fully justify the current valuation. The PEG ratio currently stands at 1.62.
Analysts forecast 11.1% annual EPS growth over the next 5 years. This implies 2016 EPS of $7.16, which translates to a valuation of $107.40 by 2016. Discounting backwards by 10% yields a present value of $66.69, which means the stock currently has around 8% more in value than what it should.
On the positive side, free cash flow trends have been fairly strong. FCF for the TTM ending 2Q12 was $5.6 billion versus $2.7 billion in 2Q11 and $3.6 billion in 2Q10. Even if we take the highest amount, however, that FCF has been over the TTM ($6.1 billion), the yield is no better than 8.8%. Earnings performance has also not been the best. The company yielded EPS that was 2.5% below expectations in 2Q12 and 1% below expectations in 1Q12. Even though this was a nominal amount off in magnitude, it's the fact that the company missed the beat that will deter investors from getting in when the economy hits a quicker inflection point towards recovery path.
A while back, the Obama administration signed a free trade agreement with South Korea, Colombia, and Panama. Legislation appears to be heading in the direction of liberalizing international trade, which UPS will be a large beneficiary of. Even Europe has seen exports rise by 9% for UPS despite the sovereign debt crisis and macro uncertainty. This may make UPS a long-term buy, but there is stronger upside in the shorter-term.
A better way to play the shift towards free trade would, however, be to back railroads. CSX (NYSE: CSX) and Union Pacific (NYSE: UNP) both look meaningfully undervalued. Whereas CSX is concentrated in the Eastern part of the United States, Union Pacific (as the largest railroad in the world) has tracks covering around two-thirds of the country. In my view, CSX is better positioned for greater growth by virtue of having more room for takeover activity that will not raise anti-trust issues. On the other hand, Union Pacific is a safe pick that operates in an industry where brand value is everything. It could very well be that, although the firm has the most tracks, growth may still be the greatest due to more favorable contracts. In any event, rail remains by far the cheapest way to cheap goods, so, if you are optimistic about free trade, I recommend going with rail stocks over UPS.
Southwest Airlines
Ditto for Southwest, which is one of the few airlines that has not gone bankrupt and still maintains an investment grade rating. Despite this standout performance, the headwinds are significant. Profit margins have fallen across the industry from cost inflation outweighing sales increases. The stock is still nevertheless just 8.3% away from its 52-week high but 29.1% below its 52-week low.
Analysts currently rate the stock a 2.6 out of 5 where "5" is a "sell." Even after forecasting a tremendous turnaround from 17.6% annual negative EPS growth over the past 5 years to positive 24% annual EPS growth over the next 5 years, analysts still only put a $11.81 price target on the firm. In my view, this does not compensate all of the risk that is involved in making an investment.
Over the past 5 years, annual FCF has averaged $262.3 million. Southwest trades at more than 26x this amount. This is simply way too expensive for a stock with headwinds from regulations and operational volatility. The business has gone up and down in revenue over the years, but the general trend has been down. EPS for the TTM in the 2007-region was around $0.80. It then dipped to around $0.50 and eventually $0 before recovering back up to $0.29 in 2010, $0.67 in early 2011, and then falling back to $0.22 - $0.40. Under such turbulence, I would rather not be flying Southwest.
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