Has FedEx Turned a Corner?

Much stronger results in its latest quarter may indicate the company's initiatives are paying off

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Sep 21, 2020
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Between January 2018 and March 2020, FedEx Corp. (FDX, Financial) had been losing the confidence of investors.

When the market rebounded after the March collapse, investors changed their minds about the company and began buying again, enough to dramatically drive up the price:25856d4b3b2be2b68748dd047d52b96a.png

In its first-quarter 2020 report to shareholders, the Third Avenue Value Fund (Trades, Portfolio) attributed the previous decline in confidence to three headwinds:

"First, the expansion and evolution of its ground delivery services in order to meet rapidly growing ecommerce demand has required costly investment and created inefficiencies in the FedEx Ground network in the near-term. Secondly, in 2016, FedEx acquired TNT to expand its European operations and grow scale within its FedEx Express line of business. This is a business that was already inherently less profitable and more capital intensive than its FedEx Ground business. From an integration perspective, the TNT acquisition has proved more difficult and a larger headwind to operating performance than anticipated. Meanwhile, political impediments to global trade in 2019 compounded the challenges for FedEx Express, which is primarily a business to business service."

Nevertheless, Third Avenue was optimistic about FedEx's future:

"Over time we would expect FedEx to navigate a return towards historical levels of profitability and returns on capital, in addition to meaningfully growing overall business volume in the future. Our estimates suggest that this should also result in a substantially higher share price."

It was that kind of optimism that drove up share prices as the market recovered in the second half of March and beyond.

The FedEx business portfolio is made up of four segments:

  • FedEx Express: This segment includes the Federal Express Corporation and TNT Express. It calls this segment "the world's largest express transportation company," and it offers time-definite delivery to more than 220 countries and territories. In fiscal 2020, which ended on May 31, it provided $35.51 billion in revenue.
  • FedEx Ground: This segment provides small-package ground delivery services. It offers low-cost, day-certain service to any business address in the U.S. and Canada, as well as residential delivery to all U.S. residences through its FedEx Home Delivery service. In fiscal 2020, it provided revenue of $22.73 billion.
  • FedEx Freight: Handles North American, less-than-truckload ("LTL") freight services across all lengths of haul. It contributed $7.10 billion to the top line.
  • FedEx Services: Sales, marketing, information technology, communications, customer service, technical support, billing and collection services, and certain back-office functions that support its transportation segments. It provided $22 million in revenue in fiscal 2020.

The optimism that drove up the share price in the late spring was confirmed, in part, by the strong quarterly results released on Sept. 15. FedEx's first quarter of fiscal 2021, a quarter that ended on Aug. 31, showed significant improvements—because and in spite of the coronavirus pandemic.

It posted these GAAP results, comparing the first quarters of 2020 and 2021:

  • Revenue: Increased from $17 billion to $19.3 billion.
  • Operating income: Went up from $1.05 billion to $1.59 billion.
  • Operating margin: Jumped from 5.7% to 8.2%.
  • Net income: Rose from $800 million to $1.25 billion.
  • Diluted earnings per share: Jumped from $2.84 to $4.72.

It attributed the improvements to:

  • Volume growth in FedEx International Priority and U.S. domestic residential package service.
  • Yield improvements at FedEx Ground and FedEx Freight.
  • An additional operating day per week (it added Sunday service).

Offsetting these improvements, to some extent, were costs incurred in supporting stronger demand and expanding services, variable compensation expenses and costs related to Covid-19 (safety).

Founder, Chairman and CEO Fred Smith summed the quarter up in these words: "Our earnings growth underscores the importance of our business initiatives and investments over the last several years, and, in many ways, the world has accelerated to meet our strategies."

Fundamentals

The GuruFocus system gives FedEx a strong 8 out of 10 rating for profitability, despite operating and net margins that are comparable with its peers and competitors in the Transportation industry.

Its financial strength is significantly weaker, receiving a rating of only 4 out of 10, and the rating is low because of the company's debt. According to its 10-K, the company expects to pay $798 million in interest on long-term debt this fiscal year.

The GuruFocus Value calculator finds FedEx is "modestly overvalued":

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Its price-earnings ratio sits at 35.97, which is significantly higher than its 10-year median of 21.23. The PEG ratio is also high at more than 9.00 while the discounted cash flow (DCF) calculation will be unreliable because the company has a predictability rating of only two out of five stars.

Turning to the dividend, we see it yields just 1.09% and is low, in part, because the share price shot up:

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The payout ratio is 38%, which is relatively low and provides lots of room for dividend growth. At the same time, though, we must remember that this is a capital-intensive business (trucks, planes, sorting plants and more), so much of its free cash flow must go into capital expenditures.

The five-year yield on cost is reasonable at 3.87%, thanks to a dividend growth rate averaging 17.6% over the past three years.

The company has bought back some shares. In January 2016, it authorized a program under which it could buy back up to 25 million shares; as of July 16, it still had 5 million shares remaining under the authorization.

Gurus

Quite a few gurus, 22 to be specific, owned shares of FedEx on June 30. Their interest was strong for a year and more recently tapered off as the price moved up again:

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Dodge & Cox had the largest position among the gurus at the end of June, 27,170,321 shares, representing a 10.37% stake in FedEx and 3.50% of its own assets. It added 0.91% during the quarter.

PRIMECAP Management (Trades, Portfolio) holds roughly half as many shares, 13,583,039 of them after reducing its stake by 1.08%.

The Bill & Melinda Gates Foundation Trust owned 3,024,999 shares at the end of the second quarter.

Conclusion

It appears FedEx has turned a corner, although another two or three strong quarters, like the most recent, would give greater confidence to investors. With greater volume, yield improvements and an extra day of business per week, it is moving forward. Perhaps CEO Fred Smith is right in believing "business initiatives and investments over the last several years" are paying off.

The stock is generally strong and, as the share price indicates, has won over many investors. As a result, the stock is considered modestly overvalued and the dividend has been pushed down.

The latter means income investors are likely to look elsewhere, for dividends with more heft. Growth investors, on the other hand, may put FedEx on their short-lists, hoping the upward momentum remains strong. Value investors will turn away because of the overvaluation (no margin of safety) and because of the debt load.

I do not own shares in any of the companies named in this article.

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