Wednesday, September 09, 2009

United Parcel (NYSE:UPS): Upgraded to Overweight at JP Morgan; $70 target established

JP Morgan is upgrading United Parcel (NYSE:UPS) to Overweight from Neutral this morning. They are raising their price target to $70 (prev. $57)

Firm notes they believe that UPS is viewed as a defensive transport name with less operating leverage and that this perception has been a major driver of the underperformance in UPS stock versus most other transports in 2009TD. In their view, UPS stock has lagged too much, and the stock does not reflect the boost a turn in the U.S. economy would provide to UPS earnings performance and to the stock. They are upgrading UPS from Neutral to Overweight.

Raising rating to Overweight as reward / risk is attractive. Relative to most other transports and many industrial stocks, JP Morgan believes that UPS reflects less anticipation of a turn in the economy, and they believe potential downside risk for UPS stock is modest, while upside potential is significant. They are upgrading UPS to Overweight from Neutral because they believe there is room for UPS stock to reflect a stronger expectation of a cycle turn in order to be consistent with the anticipation reflected in other industrial and transport stocks. They also believe UPS’s operating leverage in a turn may surprise on the upside.

Catch-up opportunity is meaningful—UPS has lagged 80% of S&P 500 Industrials. Based on 2009TD performance and also the % move of stocks off their 12 month lows, firm's analysis shows that UPS stock has underperformed about 80% of the industrial stocks in the S&P 500. While underperformance versus higher beta names makes sense to some extent, they believe that UPS’s earnings will respond earlier in the cycle relative to many industrials, and the underperformance appears overdone.

Operating leverage in 2010 could surprise to the upside. The two-year ~600 bp decline in UPS’s total operating margin in 2009 vs. 2007 reflects a much sharper decline in margin performance than we have seen in the past due to both lower revenue and also the effect of unfavorable labor mix (union seniority). While UPS is not typically viewed as a name with operating leverage, JP Morgan believes that gradual reversal of unfavorable factors that drove margin pressure could provide greater than expected margin upside in 2010.

Incrementally positive transport data points are good for UPS. While there is not yet a strong turn in transport demand, rail weekly volumes, IATA monthly freight data, and truckload company comments point to incremental improvement in demand. JP Morgan believes that gradual improvement in parcel /express volumes is also likely.

They are introducing their 2011 EPS estimate of $3.50/share and Dec 2010 price target of $70. JP Morgan's new price target is based on applying a 20x P/E multiple to 2011 estimate of $3.50/share.

Notablecalls: I like this call as JP Morgan has done a good job covering the space. They upgraded Fedex (NYSE:FDX) in late June around $50 and the stock is now trading around $70. FDX is generally considered a better name so upgrading it ahead of UPS made sense (& it clearly worked).

So now it's time to upgrade UPS, the lesser peer. I suspect this too will work. The upside to JPM's $70 target price is solid and will attract buyers.

All in all, I think UPS can trade up towards the $56 level in the very n-t. Ketchup!

PS: Note how UPS's rolling fwd P/E has almost always lagged FDX's. Only over the past months the ratio has dipped below 1x level.

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