FedEx Corporation (FDX, Financial) reported first quarter 2016 results Wednesday, and the stock fell nearly 3%. Further, from a YTD15 high of $184.98, FedEx has declined by 19% to current levels of $149.6. FedEx is an attractive investment after the correction for several reasons.
GDP growth outlook
Growth for FedEx is closely linked to both U.S. and economic growth. On Sept. 15, FedEx released its expectations for U.S. and world GDP growth. For 2016, the company anticipates GDP growth to be 2.8% in the U.S., compared to 2.5% in 2015. The company pegged world GDP growth for 2016 at 2.9%, compared to 2.5% in 2015.
Therefore, the company expects economic activity to be better in the coming year. While I believe that economic activity might not be significantly different from 2015, even if growth maintains 2015 levels, FedEx is likely to report strong results.
FedEx has mentioned geopolitical tensions and sluggish growth in emerging economies as key risks, and I agree with these points.
Increase in shipping rates
On Sept. 15, FedEx announced that it will increase shipping rates by an average of 4.9% for U.S. domestic, U.S. export and U.S. import services.
The impact of increases in freight rates will be seen in the coming quarters, and increases in freight rates coupled with relatively lower fuel charges can help FedEx expand its EBITDA margin.
According to the Energy Information Administration, oil is likely to average $59 per barrel in 2016, meaning the company’s fuel cost should remain under control in 2016. Therefore, increases in freight rates are a positive and should contribute to EPS expansion.
Robust 2016 outlook
FedEx projects adjusted earnings FY16 to be $10.40 to $10.90 per diluted share. This forecast is marginally lower compared to prior estimates. However, considering EPS of $10.60 per share for FY16, FedEx is trading at a PE of 14.1.
I believe these are not expensive valuations considering the broad market PE of 18.9. Therefore, exposure to FedEx can be considered at current levels.
It is also important to mention here that FedEx has a capital expenditure plan of $4.6 billion for FY16, which will largely be deployed towards a new fuel-efficient fleet. I therefore see healthier margins and an expanded PE in FY17. FedEx is an attractive investment from a 2-3 year perspective.
Shareholder returns
In the last year, FedEx returned $5.0 billion to shareholders in the form of share buybacks and dividends. I believe that robust shareholder returns through these two avenues will continue. During the quarter, the company acquired 1.1 million shares of FedEx common stock, and this factor will increase EPS.
FedEx also offers a dividend of $1 per share, and I believe that this is sustainable considering the company’s outlook for FY16. Therefore, there are multiple sources of shareholder value creation, and the recent correction is a good opportunity to buy this long-term value creator.
Conclusion
Even if there is some weakness in the economy, higher freight rates should offset that concern. There appears to be minimal downside potential but significant upside potential at current prices.
Long-term investors can continue to accumulate FedEx, and an investment decision can be made after the outcome of the Fed meeting Thursday. Increases in rates can result in short-term jitters for the market. However, the U.S. economic outlook remains resilient, and I see good times ahead for the stock.
