Federal Express (FDX), the iconic freight company that changed the lexicon of American business (i.e. "Fedex it") is set to report their fiscal 3rd quarter, 2013, financial results before the bell on Wednesday March 20th. Analyst consensus is looking for $1.39 in earnings per share (EPS) on $10.855 billion in revenue for expected year-over-year growth of -10% and +3% respectively. The stock is up about 18% year-to-date (ytd) as this is being written, far exceeding the SP 500's return. The stock was up about 10% in calendar 2012, and got crushed in 2011.
FDX announced last fall the restructuring of FedEX Express, which is its traditional freight business that has been plagued by slowing volumes and poor yields the last few years. Detailed to investor's in October, FDX announced that there will be $350 million in savings in fiscal '14 from the restructuring, with an overall "profit improvement" of $1.5 billion for the plan.
These aren't minor numbers of you consider that FDX has 315 million in shares outstanding, thus the cost savings in the 2nd half of calendar 2013 could see $1.50 per share in higher EPS, with the $1.5 billion over the next several years, potentially adding $5 to FDX's EPS. Forward estimates were raised for FDX after the October Investor Day, but it is unclear how much of the total restructuring is in analyst numbers.
FedEx Express is 2/3rd's of FDX's total revenues, but just 1/3rd of operating income. In the 2nd quarter, FDX Express saw US domestic volume fall 2%, while total Average Daily Volume (ADV) rose 9%, and yet "yield" fell 5% in a freight market where rates have been firm. (There is still rational competition between FDX and UPS, and it has kept prices firm in a slower economy.)
FedEx Ground, the trucks you see on the street every day, has been the real star at FDX. Started in 2000, Ground is 23% of FDX's total revenues but 2/3rd's of operating income. Last quarter, Ground's volumes were +8%, while yields were +2%.
FedEx Freight is finally starting to turn around, after being a drag on FDX's results for many quarters. Freight operating income has now grown y/y for three consecutive quarters, the first time that has happened since early 2008.
There are four important elements to FDX that a traditional retail investor needs to keep in mind:
1.) FDX's operating margin was 6.5% in fiscal q2 '13 (last quarter) and the company has always wanted to get that closer to 10% and keep it there, which it has had a hard time doing. The Express restructuring, which should take expenses out of the division, should help drive operating margin leverage, just as the global economy starts to re-accelerate;
2.) FDX's business model has both operating leverage and financial leverage. FDX has a higher fixed cost base than UPS (UPS), and in my opinion was always a better transport play when U.S. and global growth was accelerating. We are still early in the recovery - because of FDX's operating leverage, better volumes and better global growth are a bigger positive for FDX than other large-cap freight companies;
3.) FDX's operating cash-flow is just 10% of revenues and FDX's capex is roughly 80% of FDX's cash-flow (hence free-cash-flow is minimal) so FDX does not have a lot of room for the dividend and share repurchase than you are seeing from other companies in today's market, and which seems to be driving stock action;
4.) Jet fuel and the fuel surcharge matter to FDX. The best environment for FDX is faster global growth and volumes, with stable to falling oil prices. Oil and jet fuel prices matter. When crude oil and thus jet fuel prices fall, and the fuel surcharge stays on, it fattens profit margins for FDX;
In fiscal 2013 (end May '13), EPS are expected to fall 4%, but then accelerate to 24% and 19% in 2014 and 2015 for FDX, on what is expected to be mid-single-digit revenue growth. FDX currently is trading at 17(x) fiscal '13's estimate of $6.35 and 14(x) and 11(x) 2014 and 2015's estimates.
With the recent rally in the stock, FDX is now trading about 8(x) cash-flow. Technically, the stock put in a series of tops in 2006 and 2007 near $120 per share, with FDX's valuation trading at 1(x) 4-quarter trailing revenues and 10(x) - 11(x) cash-flow at that time.
Today, FDX is trading at 0.80(x) 4-quarter trailing revenues, and 8(x) cash-flow so if we compare peak valuations, then FDX has more room to run, possibly to $140 if we use peak valuation metrics from 2006 and 2007. Our internal model values FDX near $122 per share, while Morningstar thinks the stock is worth $112. If China and Japan can turn decisively, and Western Europe can stabilize and possible generate just a little growth, synchronized global growth in the U.S. economy will help FDX dramatically.
We've been long the stock for some time, suffering through a leveraged freight company in a slow economy. It looks like our patience is starting to pay off. Higher volumes run through a leaner operating business as a result of the restructuring and thus a higher operating margin, could be Nirvana for the freight giant. Operating margin expansion from the current level of 6.5% would help drive p.e expansion in FDX in our opinion.