“Value,” the great Charles Dow wrote a century ago, “is determined by the margin of safety over dividends, the size and tendency of earnings, the soundness of the balance sheet and of operating methods, and general prospects for the future.”
Let’s apply Dow’s timeless wisdom to transportation stocks. While profit warnings and a weakening economy may have tarnished their near-term prospects, you can still find value in this sector — if you know where to look.
It’s not news that transportation companies are facing strong headwinds now. The Dow Jones Transportation Average is down about 15% year-to-date. Plummeting coal volumes are punishing railroads, while driver shortages and a slowdown in global trade are chilling the outlook for truckers and package delivery giants.
But that doesn’t mean investors should automatically steer clear of transportation stocks — particularly those with a strong overall value proposition.
A day after global transportation bellwethers FedEx (NYSE:FDX) and UPS (NYSE:UPS) both made news, it’s a good time to revisit the sector. Both companies’ strategic initiatives are aimed at boosting profitability and coping with myriad pressures in a global shipping market that’s in transition.
FedEx and UPS have good business models and solid fundamentals, and appear built to last based on Dow’s criteria of value. That’s true even though near-term challenges are likely to pressure earnings and margins, and both companies have lowered their profit forecasts for the remainder of the year. But that doesn’t mean they’re the sector’s best bets.
FDX shares rose about 5% on Wednesday after the company announced an aggressive cost-cutting program aimed at boosting annual profit $1.7 billion by 2015. With more former Express customers weaning themselves off premium overnight deliveries, FDX plans to pare back those operations, cut jobs and add more fuel-efficient aircraft and vehicles to its fleets.
Investors gave FDX’s cost-cutting plan two-thumbs up on Wednesday, sending the stock more than 5% higher. With a $26.6 billion market cap, the stock is trading around $90, with an attractive forward P/E of 11 and a price-to-earnings growth (PEG) ratio of 1, indicating that it’s fairly valued.
FDX pays a safe — but scant — 0.6% dividend yield. However, it revised its earnings forecast downward last month and could see its first year-over-year quarterly profit drop since 2009.
Headwinds are battering UPS, too. Reports emerged on Wednesday that its $6.7 billion bid to acquire Dutch delivery company TNT Express could be blocked by EU regulators, who fear the deal could impair package-delivery competition.
UPS, which will next report earnings on Oct. 23, forecasts the economic outlook in Europe to remain dicey for the rest of this year and into 2013. However, its planned acquisition of TNT would give Brown the opportunity to profit from commerce growth within the 27 EU member nations. It will continue to leverage its size and technology focus to enhance its competitive position globally.
At a $69.3 billion market cap, UPS is trading around $72. Its forward P/E of over 14 and PEG ratio of over 1.4 indicate it could be in the overbought range. With its 3.1% current dividend yield and more than $4 billion in free cash flow, Brown is poised to remain the 800-pound gorilla in this market for the long haul — despite today’s difficulties.
Bottom Line: Neither FDX nor UPS has been flying under the radar, so most of the short-term upside — and downside — is pretty much priced in. Here are four other transportation stocks that might be better to buy now before earnings: