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Thursday's Top Upgrades (and Downgrades)

This series, brought to you by Yahoo! Finance, looks at which upgrades and downgrades make sense, and which ones investors should act on. Today, three new ratings in the shipping sphere are grabbing headlines, as investment banker RBC Capital Markets upgrades UPS (NYSE: UPS  ) to outperform, but cuts both FedEx (NYSE: FDX  ) and shipping facilitator Expeditors International (NASDAQ: EXPD  ) to underperform.

RBC's outperform call on UPS is essentially a buy rating, as this analyst sees the $82 stock heading to $100 over the course of the next 12 months. And RBC could be right about that.

After all, if it's true that UPS shares cost 99 times earnings, recently hit their 52-week high, and could theoretically be expected to slump back a bit, it's also true that relative to the rest of the stock market, UPS has been a pretty weak performer of late. The shares are only up 3% over the past 12 months, versus a 12% gain on the Dow. Now could be the time for UPS to begin catching up.

It's also true that UPS's P/E may not be as bad as it looks. GAAP accounting standards only permitted UPS to report earning "profit" of $807 million last year. But the firm's real free cash flow for the period was north of $5 billion. Priced at just 15.5 times free cash flow today, the stock doesn't look unreasonably priced for a projected grower near 10% paying a dividend yield near 3%.

That's not the cheapest valuation on the planet, granted. But for one member of a globe-striding duopoly, it's not a half bad price.

Sell FedEx
Speaking of the duopoly, the other member of this international shipping cartel is FedEx -- and this one, RBC doesn't like one bit.

RBC previously had FedEx pegged for the same $100 price tag it now assigns UPS. But the banker cut its stock price projection on FedEx to $87 today. Is that the right call?

Actually, I think it is. Sure, on the surface FedEx doesn't look expensive -- it costs less than 16 times trailing earnings, versus UPS's aforementioned 99 P/E. Most analysts also expect FedEx to grow faster than UPS -- nearly 13% per year over the next five years.

But here's the thing: Whereas UPS generates far more cash profit than GAAP accounting standards permit it to label "profit," FedEx does the opposite. Its $1.3 billion in free cash flow generated last year lag reported income by $505 million. Put another way, for every $1 FedEx claims as profit, it actually generates only $0.72 in real cash profits. As a result, at 22 times FCF, this 13% grower with the skimpy, 0.6% dividend yield just doesn't look worth the effort of owning to me. RBC is right to recommend selling it.

Sell Expeditors International, too
Finally, rounding out our group of three shippers, RBC slapped a sell rating on shipping logistics services provider Expeditors International of Washington -- and for reasons that are actually pretty obvious.

The stock costs 22 times earnings, but is growing at only 10% per year (per analyst estimates). It pays a 1.5% dividend yield, and generates decent free cash flow -- within $10 million or so of reported net income. Still, neither the dividend yield nor the FCF numbers are good enough to change the basic facts of valuation: At a PEG ratio of 2.2, Expeditors International is a fine business, but one whose stock price is simply too high to justify.

Again, RBC is right to recommend its sale.

Motley Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool recommends FedEx and United Parcel Service. The Motley Fool owns shares of Expeditors International of Washington.

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Related Tickers

9/30/2016 2:19 PM
FDX $174.98 Down -0.15 -0.08%
FedEx CAPS Rating: ****
UPS $109.39 Up +1.18 +1.09%
United Parcel Serv… CAPS Rating: *****
EXPD $51.58 Up +0.24 +0.46%
Expeditors Interna… CAPS Rating: ***