FedEx - Investors Are Negatively Surprised By Express Troubles

Mar.20.13 | About: FedEx Corporation (FDX)

Shares of FedEx (FDX) traded with losses of up to 7% in Wednesday's trading session. The global transportation and e-commerce firm reported a disappointing set of third quarter results accompanied by a lowered full year outlook.

Third Quarter Results

FedEx generated third quarter revenues of $11.0 billion, up 4% compared to last year. Revenues came in ahead of consensus estimates of $10.85 billion

Despite the modest uptick in revenues, operating income came under severe pressure. Operating income fell 28% to $589 million, as operating margins fell 230 basis points to 5.4%. The main reason for lower profits is the accelerating shift of demand towards lower-yielding international services.

Net income fell 31% to $361 million on the back of disappointing operating margin developments and a $47 million business realignment charge. Normalized earnings fell from $1.55 per share towards $1.23 per share over the past quarter, while GAAP net earnings per share came in at merely $1.13 per share. Both adjusted earnings, as well as GAAP earnings, fell way short of consensus estimates of $1.39 per share.

CEO and Chairman Frederick W. Smith commented on the poor results, "The third quarter was very challenging due to continued weakness in international air freight markets, pressure on yields due to industry overcapacity and customers selecting less expensive and slower-transit services."

The company will take additional measures and will reduce its Express capacity to and from Asia. The company might even retire older, less fuel efficient aircraft quicker than anticipated.

To provide any comfort to shareholders amidst the poor results, FedEx' Board of Directors has authorized a 10 million share repurchase program, sufficient to retire a little over 3% of its shares outstanding.

A Detailed Look Into The Earnings

The main problem for FedEx is its express segment. Despite the fact that revenues increased by 2% to $6.70 billion, operating income fell by two-thirds to merely $118 million. Profitability fell hard on lower fuel surcharges and customers move towards lower-yielding services.

The ground segment had a decent quarter as revenues rose 11% to $2.75 billion. Yet operating income was largely unchanged at $467 million, as operating margins fell by 180 basis points to a still very healthy 17.0%. Revenue and volume growth was largely made undone by higher purchased transportations and buyout charges.

The freight segment continued to be stagnant. Revenues came in essentially unchanged at $1.24 billion, while the business managed to squeeze out an operating income of $4 million.

Clearly the express division, which generates the majority of firmwide revenues is putting stress on the overall results as operating income fell dramatically. The revenue performance at the ground business has been very solid, but competition and one-time items have eaten into the fat margins of the business.

Outlook

FedEx expects to report adjusted earnings between $1.90 and $2.10 per diluted share for the final quarter of the year. This will result in full year adjusted earnings per share of $6.00-$6.20, down from an earlier guidance of $6.20-$6.60 per share.

Last year, the company reported adjusted earnings of $1.99 per share. GAAP earnings per share are expected to come in between $0.94 and $1.34 per share in the final quarter, as the company expects to take large charges related to its voluntary buyout program in an attempt to save on costs.

In the third quarter, FedEx took $47 million in charges related to the voluntary buyout program. The company expects to take charges of $450-$550 million for the full fiscal year of 2013, resulting in charges of $0.89-$1.09 per share. As such, net earnings are expected to come in around $4.90 to $5.30 per share.

Valuation

The company ended its third quarter with $3.4 billion in cash and equivalents. The company operates with $2.2 billion in short and long term debt for a net cash position of roughly $1.2 billion.

For the first nine months of the fiscal 2013, FedEx generated revenues of $32.9 billion. The company net earned $1.26 billion, or $3.97 per diluted share. At this rate, FedEx is on track to generate annual revenues of $44 billion, on which it could earn roughly $1.6 billion, or around $5.10 per diluted share.

Factoring in a 7% correction on Wednesday, the market values FedEx around $31.2 billion. This values operating assets around $30 billion, or 0.7 times annual revenues and 18-19 times annual earnings.

FedEx pays a quarterly dividend of merely $0.14 per share, for an annual dividend yield of 0.6%.

Some Historical Perspective

Over the past decade, shares of FedEx have roughly doubled. Shares rose from $50 in 2003 to highs around $120 in 2007. Shares lost two thirds of their value during the 2009 recession, as they hit $40 that year. Shares steadily recovered and are currently exchanging hands at $100 per share, despite Wednesday's correction.

Between 2009 and 2013, FedEx grew its annual revenues by almost a quarter from $35.5 billion to an estimated $44 billion. The company steadily increased its profitability towards an expected $1.6 billion in 2013, down from 2012's peak.

Investment Thesis

It has been October of last year when I last took a look at the prospects for FedEx. At the time investors reacted very favorable to the company's $1.7 billion profitability improvement program for the period between 2013 and 2016.

Shares traded around $90 per share at the time and advanced to highs of almost $110 earlier in March this year. After Wednesday's results shares have given up roughly half those gains. The profitability improvement program calls for annual earnings to increase by roughly $500 million per year. Note that the $1.7 billion target was a cumulative target for 2016, and not an annual target.

Adjusted earnings for its fiscal year of 2013 are expected to come in around $2 billion. As such, adjusted earnings could come in around $2.5 billion or $7.50-$8.00 per share in three years time. This estimate excludes any organic growth in revenues and profitability, as well as one-time charges.

While FedEx shows healthy growth, I am not convinced about the long term potential at these levels. Shares trade at roughly 16-17 times adjusted 2013's earnings and roughly 20 times net earnings. This valuation multiple will drop to roughly 13 times 2016's expected adjusted earnings. I find this little appealing given the operational difficulties and the low dividend yield.

I remain on the sidelines. While investors applauded the company's profit improvement program last year, they appear to be shocked in today's environment. Charges, estimated at $450-$550 million will come ahead of the benefits. Adding to that the more severe issues at the "express" division, and investors are rushing for the door today.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.