Expecting More Upside for FedEx

Strong results likely in next quarter; valuations still appealing on relative basis

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Jan 04, 2017
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FedEx Corp. (FDX, Financial) has been a value creator on a sustained basis, and I expect the stock to create value in 2017 through stock upside and dividends. Even after a rally of 30% in the last 12 months, my outlook is positive for FedEx.

Before going into the business fundamentals, I want to mention that FedEx is not expensive even after the recent upside. On Dec. 20, 2016, the company reported second-quarter fiscal 2017 results and provided an EPS outlook of $11.85 to $12.35 per share (before year-end MTM pension accounting adjustments and excluding TNT Express integration and Outlook restructuring program costs). Considering midrange of the EPS guidance ($12.1), the stock is currently trading at fiscal 2017 price-earnings (P/E) of 15.5. This is not expensive considering broad market valuations.

Further, United Parcel Service (UPS, Financial) has provided fiscal 2016 earnings guidance of $5.7 to $5.9 per share; considering the midrange of the guidance at $5.8 per share, the stock is currently trading at 19.8 times fiscal 2016 earnings. Therefore, on a relative basis, FedEx is still appealingly valued, and this backs my view that more upside is due for the stock in 2017.

From a business development perspective, the coming quarter is likely to be strong as holiday season services will be reflected in the numbers, and that should keep the momentum going for the stock besides the relative undervaluation factor.

Looking at the margin outlook going forward, FedEx is expecting to incur significant expenses over the next few years in connection with the integration of TNT Express. However, the acquisition remains favorable in the long term from a market penetration perspective. At the same time, FedEx has been investing in new aircraft fleet that will be more energy efficient. Once this fleet is completely operational, the cost escalation on TNT Express integration will be somewhat offset by cost reduction coming from fuel efficiency.

Considering the global macro perspective, there are more reasons to be bullish on FedEx in 2017. China’s manufacturing index has expanded for the fifth straight month and if recovery continues in China and other emerging economies, the outlook can be potentially favorable for FedEx in terms of organic volumes growth.

In the FedEx Ground segment, organic volumes growth is likely to sustain. Similar to the second quarter of 2017, the volumes growth will come through e-commerce and commercial package growth. In particular, e-commerce growth will be meaningful in the coming quarter, and I expect the subsegment to deliver sustained growth.

Another point that is worth noting here is that FedEx has been successful in increasing base rate along with volumes growth. In second-quarter 2017, revenue in the FedEx Express segment increased 2% due to increased base rates and higher package volume. In the U.S., revenue per package increased 3%, and freight revenue per pound increased 6%. This increase was on account of higher base rates.

In terms of challenges, FedEx's Express segment reported operating margin of 9.4% (GAAP) for second-quarter fiscal 2017, and FedEx Ground segment reported operating margin of 10.5%. However, the TNT Express segment reported GAAP operating margin of just 3.7%, and it would be interesting to see how the margin improves in the coming years. This factor is discounted in the stock price; if margin improvement comes sooner than expected, the stock is likely to have an additional upside trigger.

FedEx has been a value creator in 2016 through meaningful stock upside and dividends. I expect 2017 to be no different with the positive momentum likely to sustain. Even with upside in the last 12 months, the stock remains appealingly valued and can be considered with a time horizon of 12 to 24 months.

Disclosure: No positions in the stocks discussed.

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