5 Factors To Look At Before Buying These 3 Stocks
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
There are several factors that I recommend considering before buying transportation stocks: (1) competition, (2) returns on capital, (3) growth prospects, and macro (4) headwinds and (5) tailwinds. In general, transportation stocks suffer from high competition and are highly correlated to macro trends. Below, I review 2 stocks in the airline business and 1 in mail service business with different risk/reward.
Airlines are one of the riskiest businesses to make. As Warren Buffett once put it; they grow fast, require plenty of capital to foster that growth, and then provide little earnings in return. All the major airlines, save Southwest, have gone bankrupt. Southwest has held its own with an investment grade rating and an attractive 1.1x price-to-book ratio versus 2.5x, on average, for peers. Yet, just to give you a sense how competitive airlines are, the industry average profit margin is 3.4%--Southwest's is 1.1%. Return on invested capital stands at 2.9%.
Analysts expect Southwest's EPS to grow by a rate of 8.5% over the next 5 years. Assuming expectations are met, 2016 EPS will come out to $1.16. At a multiple of 14x, the future value of the stock comes out to $16.27 for 12.3% average annual returns when you factor in the dividend distribution. But discounting backwards by 10% yields a present value that is right in-line with the current market assessment. While I find the stock to be overvalued, I nevertheless encourage buying off of the growth prospects. In addition, free cash flow is very strong at a yield of 11.5%, which provides a nice hedge against any downside.
JetBlue is even cheaper with a 17% discount to book value and just a 12x past earnings multiple. Analysts, however, rate the stock closer to a "sell" than a "buy". JetBlue saw airline traffic rise 5.7% last month on 8% greater capacity. This has been reinforced by the International Air Transport Association's forecast for stronger profit than originally expected--a major improvement from $4.1 billion to $6.7 billion. Earnings performance has been generally better than expectations with a beat of 16.7% in the recent quarter. Yet the 4% return on invested capital will limit value creation. And despite the low multiples, deep value investors only own 0.4% of the stock and there is a strong 17.5% short interest on the float.
UPS (NYSE: UPS): Returns + Tailwinds
While UPS has more tailwinds, whether it be efficiency improvements to European operations or free trade legislations, it comes with higher multiples. Even still, the company is forecasted for a strong 9.9% annual EPS growth rate over the next 5 years on top of the 3.1% dividend yield. I am therefore recommending some exposure to UPS even if it is slightly overvalued.
The company is seeking to buyout TNT Express for 5.2 billion euros, but the European Union Competition Commission has signaled little support for the idea even after TNT agreed to conditionally divest its airline operations. They are pushing for even more concessions to ally anti-trust concerns. And the market does not seem to think the deal will fall through in light of TNT's shares trading well below the takeover price. While I do not expect the takeover to succeed in accretive terms, I find that UPS's organic momentum is enough to drive outperformance in its own right. From the Thanksgiving to Christmas period, 527 million packages were shipped--a nearly 10% growth over the same time period last year. Performance has been so strong that the company is adding staff. It also feels in a better position to increase shipping rates, such as a 4.5% hike for UPS Air services and 4.9% for UPS Ground.
And then there is a tailwind coming from the impending bankruptcy of the United States Postal Service. The state-run company is getting closer to defaulting on its $11 billion in debt--an issue that is becoming more tenuous in light of the fiscal cliff. Congress appears interested in cutting the mail service to just four days a week, which would considerably benefit UPS in the process.
TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend Southwest Airlines and United Parcel Service. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!