5 Reasons Why UPS Will Outperform: BMO

United Parcel Service Inc. (UPS) is set to make a comeback and post above-average returns as the benefits of its recent cost-efficiency initiatives outweigh "lumpiness" in near-term quarterly results, according to one team of bulls on the Street and as outlined by CNBC. 

In a note to clients published on Sunday entitled "U.S. Domestic Margins on Improving Trend," BMO Capital Markets upgraded shares of the delivery company to outperform from market perform. Analysts outlined a handful of reasons the stock is set to rally despite some near-term volatility, including an expansion and automation of its network, transformation initiatives, revenue quality improvement, and a supportive economic environment. 

(For more, see also: UPS, FedEx to Outperform: Bernstein Analysts.)

Transformation Plan Could Save Up to $1.3 Billion by 2020

"We believe that U.S. Domestic operating margins have bottomed and should gradually recover over the coming quarters as the benefits from network automation, Transformation initiatives and revenue quality improvement efforts begin to gradually outweigh the operational penalties the company is incurring the implement these initiatives," wrote BMO analyst Fadi Chamoun. 

In September, UPS outlined its transformation plan with four strategic initiatives including the growth of its business to business and business to consumer e-commerce, penetration of the healthcare and life sciences logistics market, improvement of services for small and medium-sized businesses and over 70 expansion projects. The company plans to open seven new "super hub" automated sorting facilities which it expects will be 30% to 35% more efficient than comparable and less-automated facilities.

UPS estimates the transformation initiative to cost $650 million at the midpoint, while cost savings from the plan are expected to reach $1 billion and boost earnings per share (EPS) to $1.10 at the midpoint by 2020. BMO indicates that UPS could exceed its own guidance and post an earnings surprise in late 2019 into 2020, achieving $1.1 billion to $1.3 billion in additional cost savings. 

"UPS has incurred upfront costs to add capacity across its network, implement automation and carry out other cost-cutting initiatives," wrote BMO. Given a base case EPS compound annual growth rate in the high-single-digit range over the next few years, the analyst views UPS as trading at an attractive valuation in the medium-term horizon given its current valuation levels. 

Chamoun noted that a strong economic backdrop, particularly in the U.S., should provide an additional boost to the Atlanta-based company. 

The analyst's 12-month price target of $128 implies a near 9% upside from Monday close. Trading up 0.6% at $117.46, UPS stock reflects a 1.4% loss year-to-date (YTD), compared to the S&P 500's 9.4% return over the same period.