FedEx Earnings Preview: Undervalued But Global Growth Is Needed

Jun.12.13 | About: FedEx Corporation (FDX)

FedEx Corp. (NYSE:FDX), the iconic global shipping and air freight giant whose brand is now part of the American lexicon (i.e. "FedEx it") reports their fiscal Q4 '13 financial results before the bell on Wednesday morning June 19th, 2013.

Consensus analyst expectations (per Thomson Reuters) are for FDX to print $1.97 in earnings per share (EPS) on $11.46 billion in revenues for expected year-over-year growth of -1% in terms of operating EPS on 4% growth in revenues.

Estimates have been revised slightly lower since the February quarter was reported in March '13.

The stock is up about 7.5% year-to-date, (as this is being written) lagging the SP 500, which has returned about 2(x) what FDX has for the calendar year. Also, FDX's all-time high was $120 last seen in May '06, so even though the SP 500 has traded to all-time highs this year, FDX continues to trade well below its all-time high.

In the February '13 quarter, (i.e. last quarter), FDX reported 4% revenue growth and a decline in EPS of 21% as the Freight segment reported a miss, and the Express cost realignment continues to drag on.

The challenges:

Here is a brief list of some of the negatives around FDX's operating businesses right now:

1.) China GDP has slowed, which has reduced volumes out of Southeast Asia. Can the economic rebound in Japan help regional FDX volumes? Haven't heard that yet.

2.) Customers continue to transition from air to sea shipping mediums, which has resulted in excess capacity in international freight;

3.) There was an unfavorable volume - mix combination in the Express business, which resulted in the operating margin falling 66% in Express from 5.33% a year ago to 1.76% in the February quarter.

4.) From a longer-term perspective, FDX has always had a 10% operating margin as its ultimate goal. As of last quarter, the operating margin was 5.4%, and (per our internal spreadsheet) the only time FDX has met the 10% operating margin goal was May, 2006 and May, 2007. The problem since then has been the collapse and then slow growth in global growth, which is just now in the earliest stages of changing.

The valuation:

We believe FDX is trading at pretty nice discount to what we think is peak valuation around 1(x) 4-quarter trailing sales, which not coincidentally, the last time FDX traded at 1(x) sales was May '06 and May '07, coincident with the 10% operating margin.

Today, FDX is trading at 0.71(x) 4-quarter trailing sales, so a trade back to 1(x) would put the stock closer to $125 - $130 per share.

For fiscal '14 and '15, current analyst consensus is expecting EPS of $7.40 and $9.13 for expected y/y growth of 22% and 23% which is well above 2013's 10% decline. My guess is these estimates will continue to get trimmed given FDX's normally-conservative guidance, but even if investors get just half the growth rate expected currently, with FDX trading at 13(x) the 2014 estimate, the stock looks cheap on a PE basis and PEG (PE to growth) basis.

Finally FDX's enterprise value (EV) cash-flow valuation of 6(x) continues to be very reasonable, although we would expect EBITDA (earnings before interest, taxes, depreciation, and amortization) is likely to grow mid-single digits over the long term. FDX has been scraping along at 5 - 7(x) EV to cash-flow the last 6 quarters.

Our internal model values FDX closer to $130 per share, while Morningstar puts an intrinsic value at $112 per share.

The chart:

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(Click to enlarge)

Technically, FDX is neither a screaming buy or oversold. Basically it is caught in the middle of its trading range.

Summary:

FDX can generate healthy earnings growth and maximum margins when there is volume growth across the FDX network. With the much-slower-than-expected return to global growth from the 2008 recession, the freight giant's stock has underperformed the benchmark the last few years, and is lagging again in 2013. However, we think the stock is undervalued by 25% - 30% from peak valuation, although peak earnings could be closer to $10 if we ever see a synchronized global recovery.

There is one other element to FDX's story: jet fuel prices, which are closely tied to crude oil prices. With "fuel expense" between 10% - 12% of FDX's revenues since late 2010, stable to lower crude oil prices as volume grows is a close to perfect expense environment for FDX.

FDX will likely continue to remove costs from the network as they await a global economic recovery. This will ultimately benefit the freight giant when growth returns as FDX will have greater operating leverage in the model.

FDX is a high-fixed cost business in an unfriendly economic environment. The stock will really kick in when the economic headwinds become tailwinds.

Disclosure: I am long FDX. 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.