On Jan. 20, FedEx (FDX, Financial) was trading at $123.2, the lowest level the stock has seen in two years. Over the next two months, the stock surged by nearly 33% to $163.55 on Monday, and the rally has been backed by strong fundamental factors.
Look at the valuation perspective before looking at other factors that can potentially trigger upside for FedEx. When FedEx reported third quarter 2015 earnings, the company provided EPS guidance of $10.7 to $10.9 for fiscal year 2016. Considering midrange of guidance at $10.8, FedEx currently trades at fiscal year 2016 PE of 15.5. These are not expensive valuations considering that Standard & Poor's 500 currently trades at fiscal year 2016 PE of 17.2.
The important point to note here from the company’s press release is “Our positive financial momentum should continue into our upcoming fiscal 2017, where we expect solid growth in earnings and cash flow.”
FedEx expects fiscal year 2016 adjusted earnings to be up by 20% to 22% over last year and considering the company’s statement that fiscal year 2017 is likely to be robust as fiscal year 2016, it can be assumed (ballpark estimate) that FedEx has the potential to deliver 15% to 20% adjusted earnings growth in fiscal year 2017. With the stock trading at fiscal year 2016 PE of 15.5 and considering the growth estimate, the company’s PEG does suggest that there is more upside for FedEx in the next six to 12 months.
Another important point to mention is that FedEx released its economic update on March 2, and the following factors are worth noting.
FedEx estimates U.S. GDP growth for 2016 at 2.2% and U.S. industrial production at 0.6%. Growth estimates for 2016 are not very robust; if FedEx has maintained a bright earnings outlook on these estimates, there are reasons to remain bullish on the stock.
For 2017, FedEx expects U.S. GDP growth to accelerate to 2.5% with industrial production also likely to accelerate to 2.5%. While I am uncertain on the industrial production outlook, even if adjusted earnings growth is in the range of 10% to 15%, the investment is still attractive.
Therefore, from an economic perspective, FedEx has discounted the slowdown concerns for 2016, and the stock is unlikely to decline on economic concerns. The bear case scenario would be further slowdown in China. That is one potential risk in terms of stock upside outlook and also in terms of adjusted earnings growth outlook.
Another factor to be bullish on FedEx is the company’s cost control measures that will help in expanding the EBITDA margin in the coming years. The company has already made investments in fleet modernization with B-767 aircraft to be delivered through fiscal year 2016. With B-757, the company expects 20% cost improvement and with B-767, a 30% cost improvement per trip is likely. Further, FedEx is also working toward SG&A cost reduction through retirement of redundant processes, streamlining of key support operations, organizational rationalization and sourcing improvements.
As the ecommerce market grows internationally, there is big growth potential for FedEx beyond the U.S. and Europe. I expect the company to focus on emerging markets in the next three to five years. However, that’s a long-term perspective and does not serve as an immediate stock upside trigger.
FedEx is still trading at attractive valuations considering the company’s long-term target of 10% to 15% EPS growth. With decent economic growth globally, FedEx is likely to deliver as per expectations, and this makes the company’s forward valuations attractive. It would not be surprising if the stock has another 20% to 25% upside from these levels in the next 12 months. The key risk remains a potential global recession in 2016 or early 2017.
Disclosure: No positions in the stock
