This Just In: Upgrades and Downgrades

At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." Today, we'll show you whether those bigwigs actually know what they're talking about. To help, we've enlisted Motley Fool CAPS to track the long-term performance of Wall Street's best and worst.

And speaking of the best ...
Last week's unemployment report left investors shocked. I mean, zero jobs growth? That can't be good for the economy. But according to investment banker Credit Suisse, it's not equally bad for all members of the economy.

On Friday, in the wake of the bad news, CS shifted the bets it's making on one of the biggest bellwethers of economic health: Transports. Specifically, the analyst downgraded both FedEx (NYS: FDX) and Canadian Pacific (NYSE: CP  ) to "neutral," and raised UPS (NYSE: UPS  ) and Old Dominion Freight Line (Nasdaq: ODFL  ) from "neutral" to "outperform."

So far, the media have mostly ignored the ratings on Canadian Pacific and Old Dominion, focusing instead on the higher profile (and diametrically opposed) calls on FedEx and UPS. That's fine by me. I'm not interested in buying cash-burning businesses like Canadian Pacific and Old Dominion, and Credit Suisse has always been better at predicting the success or failure of air freight firms than road and rail picks anyway. That's why I'll also focus today on FedEx and UPS.

Two if by land, two more if by air
A slow economy is no good for anybody -- but according to Credit Suisse, it may be especially bad news for FedEx. This analyst believes that the time to buy FedEx is "when economic growth is accelerating, as the business model offers more operating leverage than UPS." But that sword cuts both ways: Credit Suisse argues that even when the economic "outlook is tempered, UPS should outperform."

Why? According to the analyst, UPS has a couple of advantages over FedEx. It carries less debt than its rival and generates more free cash flow. As a result, Credit Suisse argues, "shares of UPS have consistently outperformed FDX during periods of sluggish economic growth, when GDP is in the approximately 2% range."

Lessons from history
I'm not sure history is investors' best guide in this case. FedEx well outperform UPS in a strong economy, and vice versa in a weak one. But judging by the numbers, neither stock meets my criteria for a good investment.

At first, the two companies look pretty much even. Both cost roughly 16 times trailing earnings, are pegged for low-to-mid-teens growth, and pay dividends that bolster their value further. (FedEx has the advantage on growth, UPS on the dividend yield.) But neither stock produces much free cash flow.

As Credit Suisse points out, FedEx is by far the worse company in this regard. Generating less than half its reported $1.4 billion in "net income" in the form of real free cash flow, the stock looks vastly overpriced in any economy at 39 times FCF. As the analyst says, UPS is better in the cash production department -- but not by much. Its $2.5 billion in trailing free cash flow falls about 40% shy of reported income. That gives the stock a 26-times-FCF valuation, which may be cheaper than FedEx, but remains far from "cheap." (Also, Credit Suisse's praise to the contrary, UPS today carries more debt than FedEx.)

Long story short, I wouldn't buy either one of these stocks today.

A couple of Foolish alternatives
What's a better investment? Two ideas come to mind: UTi Worldwide (Nasdaq: UTIW  ) , which had a banner day last week, sports a higher P/E than FedEx or UPS. But it's growing faster, boasts a nearly clean balance sheet, and backs up a greater percentage of reported income with real free cash flow than either of the giants do.

Another possibility: Expeditors International (Nasdaq: EXPD  ) . Credit Suisse has enjoyed some success recommending this freight logistics firm in the past, and it looks pretty good to me today, too. The firm has a net cash balance on its balance sheet, and it produces strong free cash flow. Together, these factors give Expeditors an enterprise value-to-free cash flow ratio of 18 -- not bad for a 15% grower with a 1.1% dividend yield.

If you must buy a transportation stock overnight, avoid the usual suspects, and check out these two smaller fry first. I think you'll like what you find.

Rich's reservations notwithstanding, The Motley Fool owns shares of United Parcel Service and FedEx. Also, Motley Fool newsletter services have recommended buying shares of FedEx.

Fool contributor Rich Smith does not own shares of any company named above. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 436 out of more than 180,000 members. 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.


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