Why Investors Should Sell FedEx

By all (balance sheet) accounts, FedEx (FDX) is a healthy company. Its assets more than cover liabilities, even when goodwill and intangibles are excluded. It has more than enough cash ($2.7B as of Feb/28 2009) to pay off its debt ($1.9B as of the same period). Even its expenses are well-contained, and is approximately proportional to its change in revenue.

Therein lies my problem with FedEx, and hence the focus of this research to illustrate a taking a bearish/sell position on the company. It is the historical cash flow that was poor and will only get worse due to persistent weakness in the world economy, unless significant steps are taken to improve it. At this time, investors should not be paying such a hefty premium for deteriorating cash flow. My analysis for future FCF for FDX is not optimistic.

FDX should therefore should be sold/short-sold at current levels.

Balance Sheet Analysis:

CapEx is ~ $2.9B/Yr, resulting in a negative cash flow in 3 of the 4 past years. Despite the bold-font red on its balance sheet, this is not my main reason for being negative on FDX. After all,UPS also has similar CapEx levels on an absolute basis. However, UPS also has roughly double the revenue generated compared to FDX, so on a relative level, UPS is a more attractive company.

Relative comparison - 4-year average Net Income:

• UPS = $2.86B/yr
• FDX = $1.60B/yr

From these figures, UPS has the advantage of being a bigger company with larger revenues that can look for ways to cut expenses to maintain or increase EBITDA and to justify its current P/E. FDX may not do so. These are the critical metrics for FDX (from finviz.com)

P/FCF: 28.05

• Profit Margin: 1.95%

Forecast:

• Forecast for EPS next year: 3.38 (a 44.4% increase over this year's EPS)
• Forward P/E $16.66

Current:

• Current EPS: 2.34
• Current P/E: 24.06

My problem about FDX share price is that it is not justified. Investors are paying 24x earnings on expectations for a nearly 2x PEG (P/E vs growth). That is a high expectation. The market is saying that combined net earnings from increased package shipments and cost reductions (which I mentioned would be difficult to achieve relative to competitors) will be up over 40%. Investors are paying far too much for low FCF (28x).

That is unjustifiable. This is too generous to its current share price.

Fundamental Analysis:

FDX is the first indicator for an improving economy. Shipments will increase because small business transactions depend on the Transports sector (DJTA). Companies like EBAY depend on package shippers to complete the deals.

But here's the thing. Investors have added market risks to FDX stock by pricing this already frothy outlook. The outlook is based on mainstream media reporting "less bad unemployment." They completely skip past incredibly low GDP numbers for Q1. Q2 is NOT going to be any better.

It is my view that shipments will be flat to marginally higher (5% shipment growth at best for 2009). The risk/reward is clearly on the downside.

On the cost side, let's assume that there is indeed economic growth. Oil prices will rise. Energy costs will be a problem for FDX even if shipments rise. FDX will therefore need to improve its profit margin (currently at a paltry 2%) to benefit from the so-called elusive "economic recovery of 2009."

FedEx is not asleep on these problems. It bought Kinko to provide some kind of end-to-end solution for customers. The problem was that Kinko's culture and business model had no real fit to FDX's package shipment business.

Here is one of the latest headlines to illustrate this poor business acquisition: "FedEx expects to take $1.2B in fiscal 4Q charges"

Market Price, Company Value, and Price Forecast:

In examining the EPS for the past 10 years, the average EPS is $3.32. The average growth rate was 13%. Using those figures, the value range for FDX are dependent on the range of values for a Margin of safety. The stock price range is $42 - $71:

Margin of Safety / Stock Price / % from Current Stock price

• 37.5% / $42 / -26.69% <--This is where FDX stock should be, by reducing 2010 growth rates by 5/8th against its past 10-year average.
• 50% / $48 / -16.22%
• 0% / $71 / 23.93% <-- no margin of safety applied to stock price

The above calculations use a stock price of: $57.29.

I therefore assign a company value for FDX in the range of $42 - $71. Given my argument that FDX is too richly valued at current market price, my target price is closer to the downside in the low $40's.

Top-Down Analysis:

At the time of writing, the media reported slower increase in unemployment. Listen, the unemployment in the U.S. is now 9.2%. Most of those jobs are in manufacturing and won't come back. Has the market adjusted to the lower revenue expectations? Has FDX cut enough in its costs to adjust for a 10% unemployment rate for 2009? Even the U.S. postal service has cut its level of service to cope with the economic deleveraging and reduced capacity utilization.

Conclusion and Risks to Target:

My target price is FDX in the low $40s.

Risks to my stock price target are: unexpected strength in economy, "green shoots" is an actual reality and not a myth, consumption in demand from China, Emerging markets greater than anticipated (thereby benefiting shipment growth).

Disclosure: Short position on my kaChing virtual portfolio. This portfolio is tracked by over 350 users in a community with over 370,000 registered users. Twitter users may track my blog here.

Comments

[User 427112:]

FDX continues to take market share away from Brown at a record pace and will emerge from this economic downturn with a full head of steam. You can crunch numbers all you want but it might help you to get out in the field and visit some FedEx facilities. Once you meet the people, you will see why the stock routinely does so well.

Jun 07 12:08 PM

[varmet:]

I agree with your acessment of FDX. However, "Heavy" manfacturing may come back if the cost of shipping becomes to costly.

Jun 07 01:39 PM

[unit:]

idk where you live. i live in NY and FDX reliablity and drivers are horrible. they are always late and dress and look like bumms on east 78th street. In my line of work we ship hundreds of packages and deal with alot of people and companies. Over and over again people ask for UPS. From this article i agree and numbers dont lie i see fedex going down down down.

Jun 07 05:11 PM

[roncee:]

FDX continues to take market share away from Brown at a record pace.................

That's a bunch of hooie! L L Bean the largest catalog shipper and one of Fedex's largest accounts quit Fedex and went to Brown earlier this year.

Jun 08 11:26 AM

[B Sargis:]

Great article. Fex X has much bigger concerns than the economy, fuel, or market share. They have a 230,000 member workforce that the Teamsters have been trying to organize for 25 years. Once the Senate passes the FAA bill in front of them now, and FDX can no longer hide behind the Railway Labor Act, then those employees will want the pay and benifits that UPS employees have. That will cause a major impact on all FDX's costs and rates. Any price advantage in any product or market will be gone. They will be in the real world, paying for the trucks, vacations, health care, pensions,that they currently don't .

Jun 11 02:00 PM

[TeresaE:]

FedEx and UPS are reporting losses even though they never truly adjusted down their rates to customers after the price of gasoline/transportation plunged. Not to mention FedEx's rash cost cutting including slashing pay and benefits.

The reason these companies in particular are having such a rough time is simple: We have systematically ran the small business out of the country while declaring cheap socks and "too big to fail" corporations the goals of our country.

Small business used to account for 70% of non-government jobs (now less than 50%) and nearly 60% of tax revenues.

By looking at reality, the FedEx/UPS numbers, it should be apparent that small business is shutting down in droves.

I predict, just as the airlines, insurance industry, office supply industry and automotive, the small business shippers will be lining up to the government trough soon enough. Their customers are being bankrupted and all signs point to more pain coming.

Just more green shoots.

Jun 19 09:42 AM

[Jack47:]

"230,000 members of a workforce that the Teamsters have been trying to organize, no health care or vacations????" Wow, you are completely uninformed and are clearly pushing an agenda. FDX doesn't have that many contractors and they would be the targets that the teamsters are going after (only 285,000 employees company wide.) The majority of FDX employees do have health care, vacations, pensions, and receive equal or better pay than UPS employees. If FDX work conditions were so unfair why are they always ranked higher than UPS, in the "best places to work" national rankings. Those results come directly from their employees, so they can't be too unhappy.... The RLA is a tough one, but did you know that UPS has unsuccessfully tried to qualify for it 3 times..... reasoning UPS was a truck company from its inception, where as FDX was an airline. As for market share, companies like LL Bean flip carriers every couple of years mainly for price not service. Where market share is gained is in the small to medium sized business sectors which UPS has neglected for years and FDX has been able to successfully target. Both companies face an uphill battle in this economy.

Jun 19 11:13 AM

[B Sargis:]

Jack47, UPS has never tried to get the Labor Dept. to place it's employees under the RLA. The question has always been about FDX non avaition employees not being under the NLRA. And if you don't think that the Teamsters Union would not go after all 230,000 package handlers and equipment operators, you don't understand the union mindset. I can assure you that Fred Smith is not comfortable about how content his workforce is, and weither they wouldn't want union representation and all that goes with it.

Jun 25 09:10 AM