(UPS) United Parcel Services Analyst Remains Neutral on Shares

We are maintaining our long-term Neutral recommendation on United Parcel Services (UPS). The stock retains a Zacks #3 (Hold) Rank for the short term (1-3 months).

We are cautious on the company’s top-line growth, citing weak demand, high unemployment, uncertainty surrounding government debt issues, and softness in the U.S. economy. Nevertheless, management expects that solid yield and improved pricing will fuel top-line growth. United Parcel expects to deliver healthy revenue and margin expansion, driving earnings per share above the previous peak levels. In addition, it expects to post record profits this year.

Coming to the third quarter results, earnings per share were impacted by the weak Asian exports, but outpaced the Zacks Consensus Estimate as well as the year-ago earnings on healthy US Domestic Package as well as Supply Chain and Freight performances. This also supports our wait-and-watch approach at present, as we believe exports from Asia will improve in the next quarter on holiday shipments, product launches and low inventories with a gradual increase of consumer spending and a slowly improving economy.

Further, the world’s largest package delivery company estimates its revenue and earnings to grow a respective 6%–8% and 10%–15% annually from 2011 to 2016. United Parcel continues to return cash to shareholders in the form of increased dividends and share repurchases. The company started the year with an 11% hike in its quarterly dividend to 52 cents per share from 47 cents. With respect to buyback, United Parcel boosted its repurchase capacity by 35% to $2.7 billion for the year and targets repurchasing a minimum of $8 billion stocks from 2012 to 2014.

Over the long term, United Parcel will primarily focus on health care markets, which could be a significant contributor to future growth. Further, the company continues to develop in emerging markets including France, Latin America, Vietnam, China, and Korea and plans to invest about $500 million toward new technology and facility expansion over the next few years. The company projects return on invested capital of at least 25% by 2014 and free cash flow to exceed 100% of net income each year.

Although revenue and earnings growth projections coupled with the hike in shareholder returns inspire our optimism for the long term, sluggish economic growth, surging fuel prices, unionized workforce and intense competition particularly from FedEx Corporation (FDX) could restrict the near-term upside potential.

Additionally, United Parcel derives a significant portion of its revenue from the international operations, including its business in the emerging markets that are more volatile than those in the developed world. Any broad-based downturn in these markets could reduce the company’s revenues and adversely affect the financial position of the business. Further, half of the company’s international revenue stems from Europe, where the sovereign debt concern is weighing on the pace of recovery.

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