By all (balance sheet) accounts, FedEx (NYSE: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)
- Profit Margin: 1.95%
- Forecast for EPS next year: 3.38 (a 44.4% increase over this year's EPS)
- Forward P/E $16.66
- 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.
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.
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).