Thursday, January 10, 2013

FedEx Equity Research and Analysis

Please forgive the odd bit of cod philosophy that creeps into these articles from time to time. I’m really not trying to reinvent the wheel. Well actually, I’m lying. I am. In my opinion, markets don’t move in lock step with metrics no matter what the modern portfolio theory tells you, and I think a bit of metaphysical speculation can do you good. Such considerations came to mind when considering FedEx’s (NYSE: FDX) latest results.

FedEx Research

In a sense FedEx is following a classic pattern of corporate behavior at the moment. It saw global growth improving since 2009 and then pursued a path of investing in its premium Express service for the US while expanding its international Express offerings. The idea made perfect sense, only global growth didn’t quite work out as strong as FedEx would have hoped. Investors were disappointed. Impairment charges followed along with planes being retired.

After the reality set in and FedEx realized that top line growth wasn’t going to be as easy to achieve as it might have hoped, it then embarked in promising investors cost cuts and the generation of operational efficiencies in order to boost the bottom line.  Indeed, FedEx is promising $1.7 billion of profitability improvement within three years with a large portion of them achieved by the end of fiscal 2015.  So far so good, and investors need to understand that in a slow global economy FedEx’s customers are increasingly willing to use its cheaper and slower Ground and Freight services rather than its premium Express service.

So the investment proposition at FedEx has slowly shifted from being a growth punt (because international trade can increase more than GDP growth, think about it) to one where cost savings will help boost the bottom line.

How FedEx Makes its Money

Of course the shift in emphasis has turned FedEx into more of a value ‘outer’ proposition rather than growth play per se. There is nothing wrong in this, but the relative merits of the differing qualities will attract different types of investors to the stock. The growth investors will file out in disgust at the lack of growth while the value hunters' eyes will open up with excitement. See what I mean about philosophical speculation?

It is a similar story with its great rival UPS (NYSE: UPS), which also recently claimed that it was aiming to achieve bottom line growth despite a slowing global growth environment. UPS is forecasting a 5-7% improvement in adjusted EPS. In addition, UPS also saw domestic US revenues rising (driven by e-commerce growth) while international revenues grew a paltry 1.2% in terms of export volumes.  Sound familiar?

As for FedEx, how it makes its money is changing.

The decline in Express profits is obvious and the restructuring is an obvious necessity. Longer term, FedEx has good growth prospects in the Ground segment from burgeoning e-commerce traffic.

Freight margins improved thanks to operational efficiencies, but margins at Ground were weaker due to increased fuel costs. Express margins decreased partly as a consequence of the extra investment needed, while the top line suffered due to the ‘trading down’ effect to Ground and Freight as discussed above.

FedEx’s Guidance and Growth Forecasts

I’ve previously discussed FedEx’s GDP forecasts in an article linked here, and the only notable change from last quarter is that its 2013 global GDP forecast has been lowered to 2.5% from 2.7% last time around. The US GDP forecast for 2013 is unchanged at 1.9%.

Investors need to take note, because I think FedEx’s forecasts are more accurate than the Federal Reserve's.  As for its own EPS forecasts, they were left unchanged for the full year at $6.20-$6.60.

Where Next for FedEx?

In keeping with the theme here, I’m going to conclude with some philosophical musings. I think FedEx (and UPS) are mainly held as a kind of proxy for global growth. With UPS you get a decent dividend, but FedEx’s is nothing to write home about. There is potential upside from declining fuel costs but these things usually occur when the overall economy is weak, and their top lines will concomitantly be weaker too.  E-commerce growth offers a long term growth kicker, but in reality these remain solid if un-spectacular GDP plays

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