photo credit: atennies94

The following article is a reprint of my February 27, 2008 RealMoney column.

A long UPS/short FDX paired trade could work, but I’d wait for a pullback to $65 before UPS would tempt me as a long-only play.

My bullish November 2007 Landstar (LSTR - Annual Report) column represents my most successful pick for RealMoney to date. The stock is up 20%, compared to a 6% decline in the S&P 500. Landstar has also outperformed CH Robinson (CHRW - Annual Report) by 9% since I predicted as much in December, and YRC Worldwide (YRCW) has underperformed the S&P by 10% since I advised looking elsewhere.

Given that my transportation picks seem to be working out better than my others, I decided to push my luck with another long-short idea. This time, I think United Parcel Service (UPS) can continue its recent outperformance relative to FedEx (FDX - Annual Report).

Two years ago, I wrote briefly about the relationship on my blog, saying:

FDX has greater operating leverage and will continue to outperform as long as the economy continues to expand and trucking capacity remains tight…. Timing this switch is the difficult part.

Over those two years, the timing has clearly happened. UPS has outperformed FedEx by about 10% since then, and by 25% in the last 12 months.

Other than the operating leverage, I think the stocks are similar enough that a long-short trade would truly offset much of the risks. Clearly the macroeconomic and industry exposures are similar.

FedEx is expected to grow slightly faster (15% compared to 13% for UPS) over the next five years and has a lower P/E multiple. But UPS generates far more free cash flow. The free cash flow yield at UPS is 5.3%, compared to just 2% at FedEx. The cash flows can be used to buy back shares, pay dividends, or make acquisitions. All of these could boost the EPS growth rate for UPS. Because of the higher yield, I think there is much less downside for UPS.

UPS also tends to have slightly higher earnings quality, on average, than FedEx. I use the accrual ratio, which measures the difference between cash earnings and accounting earnings, as a proxy for earnings quality. This ratio is less volatile for UPS and tends to be closer to zero in most periods, both of which give me more confidence in the earnings reported by UPS (though earnings quality at FedEx is by no means poor.)

Source: Zacks Research Wizard, compiled by William Trent

The differences in performance, however, are only relative. Long-only investors have been disappointed by UPS over time, with the shares trading within 10% of the current price for the last two years, and within 20% for the last five. In fact, UPS is almost exactly in the middle of its long-term trading range.

I think the future performance will remain uninspiring. The 5.3% free cash flow yield is reasonable and offers some downside protection, but is not enough to juice returns. At roughly five times book value and 16 times earnings, I don’t see a huge opportunity for expanding valuation. The tight trading range has also means there is little advantage to a put-write strategy. Low stock volatility means the March $70 puts offer just over a 1% premium. That isn’t enough for taking the risk that the stock falls to the low end of its trading range – though I’d be much more favorably disposed toward UPS if the stock pulled back to $65 or so.

For the reasons outlined above, I think a paired trade going long UPS and short FedEx could continue to work over the next few months.

Disclosures: William Trent is long Landstar (LSTR - Annual Report)

Zacks Investment Research has provided Stock Market Beat with a complimentary trial subscription to Research Wizard.

This column originally appeared at RealMoney on November 19, 2007

Along with most of the rest of the trucking industry, the news on Friday from FedEx (FDX - Annual Report) and YRC Worldwide (YRCW) sent shares of Landstar (LSTR - Annual Report) down sharply, briefly causing it to breach the 52-week low. Landstar has long been one of my favorite names, and I took the opportunity to buy some shares because I think the current valuation will be tough to beat.

Don’t get me wrong – I’m not arguing that trucking revenues are about to ramp up across the board. As the chart below shows, the industry has been slowing since early 2006 and despite the little uptick in September the year/year change was a decline of 2.3%. Demand for trucking services is bad, and the slowing U.S. consumer suggests that it will probably get worse before it gets better.

Source: American Trucking Associations

No, the main reason I like Landstar for the long haul (har!) is their business model. Rather than own their own trucks, they outsource the loads to owner operators who provide their own rigs. The business capacity owners (BCOs in Landstar terminology) get the lion’s share of the revenue for the load, which encourages them to haul as many as they can. This is a virtuous cycle that benefits both Landstar and their BCOs. More than 30,000 rigs are in the Landstar network, though some are much more active than others.

But the benefit isn’t just incentives to work harder. The revenue sharing process means that most of Landstar’s expenses are variable rather than fixed. When business is slowing for the trucking industry as a whole, Landstar’s expenses fall in proportion to any decline in revenues and the company is able to remain profitable.

For regular trucking companies like YRC, each unassigned truck is a drag on profitability. The truck certainly represents a depreciation expense and could also represent an economic expense if it is leased or purchased on credit. Every truck without a driver hurts the company.

At Landstar, an empty truck hurts the driver, who then has that much more incentive to haul some merchandise, earn some money and make the truck payment.

Industry Slowdown?

Although Landstar reported a 3% decline in total revenue during the first nine months of 2007, the decline was mostly due to a fall-off in one contract. The company provides disaster-relief services for FEMA and the milder hurricane season in 2006 led to lower revenue in early 2007 than was experienced post Katrina and Rita for 2005/2006.

According to Landstar’s latest 10Q, revenue would have been up 5% excluding FEMA business in both years. Contrast that with the decline in overall industry revenues, and I smell market share gains. The industry may be slowing down, but I don’t think Landstar is.

Cheap Growth

Over the last 12 months, Landstar generated $167 million in free cash flow. Nearly all of its operating cash goes to share repurchases and dividends since the company isn’t buying trucks. On a $2.1 billion enterprise value, that amounts to an 8% free cash flow yield – more than twice the yield on Treasury bonds and a healthy risk premium in today’s market.

What’s more, Landstar’s 5% apples-to-apples growth in a bad year suggests the longer-term growth rate could be significantly higher. With today’s price justified even without any growth, the prospect of an eventual return to double-digit growth rates gets my mouth watering.

Sure, the P/E of 17x is significantly higher than YRC’s 6x. But the lack of capital requirements, the absence of YRC’s $1.5 billion in debt and the variable cost nature more than justify the higher P/E in my opinion.

Disclosure: William Trent owns shares of Landstar (LSTR - Annual Report)
Note: Sometimes signing up for airline credit cards is the best way to save up miles for a vacation.

UPS (UPS) today reported a 7.2% increase in diluted earnings per share for the second quarter to $1.04 on a 3.9% gain in revenue. Strong performance by the international package segment and encouraging trends in supply chain and freight overcame a challenging U.S. small package market. Consensus estimates were calling for $1.03 on $12.23 billion in sales.

There was nothing really significant about the report for investors in UPS. Margins improved slightly, but EPS grew at the low end of management’s long-term guidance range of 6-10%. Guidance of $0.99-$1.04 for next quarter’s earnings has a midpoint below the current $1.02 consensus. Cash flow was strong as usual.
I said in my earnings preview that UPS tends to provide a good read on the overall economy.  If the U.S. small package market is weak, that says something about the strength of the U.S. small businesses and consumers who buy and sell the items being shipped. Given that the large trade imbalance shows that U.S. consumers are helping support the world’s manufacturers, one then has to wonder how long the international package segment will post a strong performance.

Rolling all of the segments together, the 3.9% gain in revenue is fair but not great. The world economy has been growing faster in recent years. For U.S. centric investors, the international exposure is a great help, though, as the growth there was far greater.

The Economic Calendar is quiet in the early part of this week but there are important reports at the end of the week. On Thursday is the Durable Goods report, for which the consensus estimates a 2.0% increase. On Friday is the Preliminary Estimate of 2Q GDP, which the consensus has pegged at 3.2%. That sounds a little high to me based on the economic data table I’ve been compiling.

EconomicData

The Earnings Calendar is as busy as it can get. Some of the names I’ll be watching:

Monday

• Altera (ALTR) - Xilinx (XLNX)  filed an awful report. Can Altera do any better? Consensus is $0.19 EPS on sales of $314 million.
• Hexcel (HXL) - This Small Cap Watch List (Track at Marketocracy) member was seeing rising estimates until last month, when they were cut from $0.20 to the current $0.17.
• Steel Dynamics (STLD - Annual Report) - The Mid Cap Watch List (Track at Marketocracy) member is expected to earn $1.04 on sales of $948 million.
• Texas Instruments (TXN - Annual Report) - expected to earn $0.42 on $3.45 billion in sales.

Tuesday

• CH Robinson (CHRW - Annual Report) - estimates have been rising and now stand at $0.47, but Landstar (LSTR - Annual Report) disappointed.
• CDW Corporation (CDWC) - stellar monthly sales reports have kept estimates rising. They now stand at $0.97.
• EMC Corporation (EMC - Annual Report) - The big news is still the VMWare IPO, but it is also a decent look at enterprise tech spend.
• Laboratory Corporation of America (LH) - The Mid Cap and Large Cap Watch List (Track at Marketocracy) member has been seeing positive earnings revisions and is now expected to earn $1.09 on $1.03 billion in revenue.
• Lexmark (LXK) preannounced and will probably offer poor guidance.
• Linear Technology (LLTC) - expected to earn $0.35 on $267 million in sales.
• Norsk Hydro (NHY) - The Large Cap Watch List (Track at Marketocracy) member has no analyst coverage right now.
• Plantronics (PLT) - my covered call position is now being cashed out so I’ve no skin in this one. But it is often volatile.
• United Parcel Services (UPS) is a great read on the health of the economy. Expectations are $1.03 on $12.23 billion in revenue.

Wednesday

• Arkansas Best (ABFS) - after Landstar’s (LSTR - Annual Report) weak quarter I’m expecting a poor showing. Estimates have come down to $0.67, but may not have come down enough.
• Colgate Palmolive (CL) - Large Cap Watch List (Track at Marketocracy) member unlikely to surprise much. Consensus is $0.83 on $3.31 billion.
• Corning (GLW - Annual Report) - is LCD supply/demand back in balance?
• Freeport McMoRan Copper & Gold (FCX - Annual Report) -Another Large Cap Watch List (Track at Marketocracy) member with dramatic positive earnings revisions, now standing at $2.71.
• Graco (GGG) is another Large Cap Watch List (Track at Marketocracy) member. Estimates have been coming down and are now at $0.61.
• MEMC Electronic Materials (WFR) - Is polysilicon supply catching up to demand for this Large Cap Watch List (Track at Marketocracy) member?
• Xerox (XRX) - can they make the numbers without asking investors to ignore a bunch of stuff? I don’t doubt they will earn $0.27 as expected but wonder how they’ll get there.

Thursday

• Federated Investors (FII) is on the Large Cap Watch List (Track at Marketocracy) and expected to earn $0.54.
• Ingram Micro (IM) is on the Small Cap Watch List (Track at Marketocracy) and expected to earn $0.36.
• KLA-Tencor (KLAC) - I know the semiconductor equipment fundamentals stink. I want to know how much and whether it is priced in.
• NII Holdings (NIHD) is on the Large Cap Watch List (Track at Marketocracy) and expected to earn $0.49.
• Western Digital (WDC) is on the Large Cap Watch List (Track at Marketocracy) and expected to earn $0.36.

Disclosure: William Trent has a long position in SMH.

FedEx Corporation (FDX - Annual Report) reported earnings of $1.96 per diluted share for the fourth quarter ended May 31, compared to $1.82 per diluted share a year ago. The quarter’s results include a gain from a settlement with Airbus related to the A380 order cancellation, which had a net benefit to earnings of approximately $0.06 per diluted share.

The $1.90 in earnings, excluding the gain, was below the average analyst forecast of $1.98 but above the $1.85 estimate that spooked the market on Monday. The net result is the stock rallied on the news, offering further support to the thesis that not all expectations are created equal.

FedEx blamed the shortfall on a slowing economy, a condition the company expects will reverse:

FedEx expects earnings to be $1.45 to $1.60 per diluted share in the first quarter of fiscal 2008 and $7.00 to $7.40 per diluted share for the full year, assuming an improvement in the U.S. economy beginning in the late summer or early fall. Earnings growth is expected to be below the company’s long-term 10% to 15% earnings growth target due to continued soft economic growth and to planned investments to expand the company’s networks and broaden its service offerings. Capital spending for fiscal 2008 is forecast to be approximately $3.5 billion, of which approximately 70% is targeted for growth.

The consensus estimate for next quarter was $1.66, with a full-year estimate of $7.39. Key to the forecast will be whether the economy does indeed improve in late summer or early fall. I think that is a tough call either way.

This weekend I previewed earnings for FedEx (FDX - Annual Report), saying:

FedEx (FDX - Annual Report) on Wednesday. Estimates are for $1.98 on $9.14 billion in sales. Since this is already at the lower end of management’s guidance, falling short would likely be very disappointing.

But falling short is exactly what one highly regarded analyst now expects, according to this article:

FedEx Corp. is expected to release below-estimates quarterly results on Wednesday, according to media reports.According to Forbes, Bear Stearns analyst Edward Wolfe reduced his earnings estimates from $1.98 per share to $1.85 per share.

Wolfe said in a report to clients that the package business, both within the U.S. and abroad, has slowed down significantly during the first half of 2007

Wolfe’s comments sent the shares down today, but if he is right and the company does report $1.85 on Wednesday I expect they will be down quite a bit more.

Earnings are due this week from:

• Best Buy (BBY) on Tuesday. The estimates of $0.51 on $7.84 billion in sales have come down during the quarter but the stock hasn’t.
• Circuit City (CC) on Wednesday. The estimates of a loss of $0.32 on $2.43 billion in sales have come down during the quarter along with the stock.
• FedEx (FDX - Annual Report) on Wednesday. Estimates are for $1.98 on $9.14 billion in sales. Since this is already at the lower end of management’s guidance, falling short would likely be very disappointing.

The Economic Calendar looks pretty light.

The Economic Calendar is relatively light this week. Potential market movers include:

• Wednesday’s Durable Goods report (consensus 2.2%)
• Friday’s advance report on Q1 GDP (consensus 1.8%)

Earnings are another story. We are in the peak part of earnings season this week. A few of the stocks we follow:

Monday

• Altera (ALTR) - valuation is rich but looks set up to beat on earnings.
• Texas Instruments (TXN - Annual Report) - March and June quarters have both had significant downward revisions. Will day of reckoning be forestalled?

Tuesday

• AU Optronics (AUO) - Forecasting losses, but panel business may have bottomed out.
• CDW Corporation (CDWC) - 14.6% sales growth doable given Berbee acquisition.
• CH Robinson (CHRW - Annual Report) - Could beat.
• CSG Systems (CSGS) - earnings should be a piece of cake. If private equity buyers don’t take them out they’ll do it themselves the slow way.
• Lexmark (LXK) - Estimates are doable but we’re always waiting for this company to trip up.
• ST Microelectronics (STM) - Doing the right thing. Hopefully will pay off.
• AT&T (T - Annual Report) - Estimates and stock both keep rising.

Wednesday

• Apple (AAPL) - Hunch: company will blow away earnings, issue horrible guidance and blame it on iPhone build.
• Arkansas Best (ABFS) - We’re staying away from truckers who own trucks.
• Corning (GLW - Annual Report) - current quarter ok, guidance at risk.
• LSI Logic (LSI) - May blame their poor guidance on Agere.
• Maxim (MXIM) - Company is out of gas but focus will be on whether they might sell out.
• Qualcomm (QCOM) - Nokia Nokia Blah Blah Nokia ad nauseam (excerpt from pending conference call transcript)
• Silicon Laboratories SLAB - Sold wireless just when biggest customer began to recover. What other surprises may be in store?
• UPS (UPS) - They shouldn’t have trouble beating the estimates (but that doesn’t mean they won’t).
• Xilinx (XLNX) - Altera with more risk to the earnings target.

Thursday

• Curtiss Wright (CW - Annual Report) - PPI data suggests they should beat big, but it suggested the same last quarter.
• KLA Tencor (KLAC) - Another place we’d rather not be right now.
• Microsoft (MSFT - Annual Report) - Vista is still not living up to expectations.
• MEMC Electronics (WFR) - Earnings surprises have been getting bigger each quarter. Now that we’ve put a semiconductor name on our Large Cap Watch List (Track at Marketocracy) it will probably stop just to spite us.
• YRC Worldwide (YRCW) - See Arkansas Best.
• Sandisk (SNDK - Annual Report) - Will take more than one quarter to clear the channel inventory.

Friday

• Dassault Systemes (DASTY) - We like Ansys (ANSS) better but don’t see why this name wouldn’t beat.
• Ceradyne (CRDN)  - Earnings could be anywhere and don’t really matter.

Enjoy!

Disclosure: William Trent has a long position in SMH.

Producer prices up 1 percent in March - Yahoo! News

Overall producer prices rose 3.2 percent from March a year ago, the biggest climb since a 3.8 percent 12 month gain to August 2006.However, core producer prices rose 1.7 percent from the same period 12 months ago, down from a 1.8 percent year-over-year rise in February.

That’s all well and good, but also well reported. However, we like to dig a little deeper and see which industries are benefitting from pricing power, as it could help us identify interesting stock ideas. The PPI charts are from the Bureau of Labor Statistics and presented as the year/year percentage change in price.

Highlight: Anyone know a good pure play in the turbine business?

Fruit and vegetable canners have pricing power:

And it still isn’t showing up in Del Monte’s (DLM - Annual Report) stock price:

Corrugated box prices are getting weaker:

Which may be a signal that demand for them - say, from FedEx (FDX - Annual Report) - is weak:

Given what’s happening to chemical pricing:

We think Dow (DOW) should be more receptive to buyout talks.

All the buyers for industrial valves:

Should be good for Curtiss Wright (CW - Annual Report).

Scarily for DELL (DELL) and Hewlett Packard (HPQ - Annual Report), computer pricing may only get worse.

Finally, semiconductor prices have taken a turn for the worse.

That should be enough to chew on over the weekend.

Disclosure: William Trent has a long position in SMH.

Shares of non-asset based transportation and logistics provider UTi Worldwide (UTIW) fell sharply today after the firm Reported Fiscal 2007 Fourth Quarter and Year-End Financial Results:

For the fourth quarter of fiscal 2007, gross revenues increased 31 percent to $951.3 million from $728.2 million in the prior-year fourth quarter. Net revenues also increased 31 percent to $331.2 million for the fourth quarter of fiscal 2007 from $253.7 million in the prior-year fourth quarter. Continued organic growth across all geographic regions, as well as contributions from the company’s March 2006 acquisition of Market Industries, Ltd., contributed to the fiscal 2007 fourth quarter revenue growth. After adjusting for the impact of acquisitions made by the company since November 1, 2005, as well as currency fluctuations on the comparison of UTi’s results, gross and net revenues each grew organically by 14 percent in the fiscal 2007 fourth quarter, when compared with the corresponding period a year ago.Operating income in the fourth quarter of fiscal 2007 rose to $32.8 million versus $17.5 million in the fiscal 2006 fourth quarter. Net income for the fiscal 2007 fourth quarter was $23.6 million, or $0.24 per diluted share, compared with $9.7 million, or $0.10 per diluted share, in the fiscal 2006 fourth quarter.

Consensus estimates called for $0.26 per share on $935 million in revenue. Because the miss related to cost issues rather than top-line growth, investors appeared to treat the miss as company specific, according to this Reuters report:

In a research note R.W. Baird & Co. transportation analyst Jon Langenfeld described the quarter as “disappointing, adding “top-line growth was solid and ahead of our expectations, but elevated costs drove meaningful earnings miss.”

Bear Stearns analyst Edward Wolfe also noted that revenue was stronger than expected, but added “UTIW has not yet straightened out its cost structure.”

However, we wouldn’t be so quick to attribute the revenue gains, more than half of which came from acquisitions, to a strong transportation environment. Recent data have shown a slowdown in trucking, a disappointment from FedEx (FDX - Annual Report), and other signs that fewer goods are being moved about. Meanwhile, the shares of companies similar to UTi such as Large Cap Watch List (Track at Marketocracy) member Expeditors International (EXPD) and Small Cap Watch List (Track at Marketocracy) and Mid Cap Watch List (Track at Marketocracy) member Landstar Systems (LSTR - Annual Report) have held up well.

It is quite possible that today’s disappointment will not spread to these other names, and we continue to like the non-asset based transportation names as long-term investment plays. However, in the short term we wouldn’t be surprised to see the weakness spread to more of the transports.

Update: We missed the fact that the railroads also had a setback, but apparently that, too, is company-specific.