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Shares of FedEx (FDX) jumped up in Wednesday's trading session after the transportation giant reported first quarter results.

The earnings report indicates that the company is on track with its plan to cut costs, thereby boosting earnings in the coming years.

Despite the reasonably solid results, I remain on the sidelines based on the fair valuation and little appealing dividends.

First Quarter Results

FedEx generated first quarter revenues for its fiscal year of 2014 of $11.02 billion, up 2% on the year before. Revenues came in slightly ahead of consensus estimates of $11.00 billion.

Net earnings rose by 7% to $489 million, as diluted earnings per share advanced to $1.53 per share. Earnings came in above consensus estimates of $1.50 per share as FedEx is making solid progress on its cost cutting efforts.

Important for shareholders, FedEx remains focused and committed to improve operating profitability at its FedEx Express division. The company targets a $1.6 billion cumulative operating improvement through the end of the fiscal year of 2016. It is margin expansion at the Express division and continued growth in the Ground segment which should support and drive the future valuation of the company.

A Look Into The Results

The large Express segment has shown some marked improvements. While revenues fell by 0.3% to $6.61 billion, profitability improved markedly. Operating income was up by 14% to $236 million as operating margins improved by 50 basis points to 3.6% of total revenues.

Revenues were under pressure on lower fuel surcharges and one fewer operating day. International exports grew by 4% as economic packages where in demand, while priority mail was out of favor as customers opt for cheaper shipping options. Global customers are adjusting to the "new normal" and are happy to take delivery a few days later at much lower prices. Lower expansion expenses, job cuts and the modernization of the aircraft fleet should support a continued sustainable lower cost base.

The hugely profitable Ground segment reported a solid 11% increase in revenues, which totaled $2.73 billion. Operating earnings rose by 5% to $468 million as operating margins fell by 100 basis points to 17.1% of total revenues. Notably home delivery and commercial deliveries rose, driven by the continued growth of e-commerce. FedEx is well positioned to benefit from new technology product introductions, as many consumers order tablets or other gadgets plus associated accessories online. Margins were under pressure on network expansion costs and one fewer operating day.

The smaller Freight segment reported a 2% increase in volumes, totaling $1.42 billion. Operating income rose 1% to $91 million, resulting in steady operating margins of 6.4%.

And The Remainder Of The Year

FedEx sees full year earnings growth of 7 to 13% from last year's adjusted earnings. Key underlying assumptions for this outlook are current fuel prices and solid growth in US and global GDP. The exposure to the global and US economy is large, so is the exposure to world trade. The downside is that FedEx is already a large player in the market, making it difficult to "outgrow" the general world economy.

The earnings guidance implies that earnings are expected to come in between $6.63 and $7.01 per share. Consensus estimates for full year earnings stood at $6.97 per share. Note that last year's earnings were heavily impacted by accelerated aircraft depreciation charges in the final quarter.

FedEx Express will raise shipping rates by 3.9% in January of 2014, and it is still to be seen how customers will react to this. Ground and SmartPost price changes are not yet available, while the Freight division has increased rates by 4.5% in July of this year already. The effects of this has already been seen as many customers shifted toward cheaper delivery options.

Valuation

FedEx ended its first quarter with $5.10 billion in cash and equivalents. Total debt stood at $3.00 billion, for a net cash position of around $2.1 billion.

FedEx is on track to generate annual revenues of around $45 billion for the fiscal year of 2014, on which it could earn some $2.1 billion in adjusted earnings.

Factoring in gains of 2%, with shares exchanging hands at $114 per share, the market values FedEx at $36 billion. This values operating assets of the firm at some $34 billion, or 0.75 times annual revenues, and 17 times earnings.

FedEx pays a very modest quarterly dividend of $0.15 per share for an annual dividend yield of 0.5%.

Some Historical Perspective

Long-term holders in FedEx have seen relative modest returns. While globalization and the emergence of e-commerce have boosted the business, shareholders have only benefited to some extent. Shares traded in a $100-$120 range between 2005-2007, to fall to lows in their mid-thirties by 2009.

Following a steady recovery, shares have rallied back to $115 again, which means investors have not made any progress over the past 8 years. Dividend yields of 0.5% at the moment have been very modest as well.

Between the fiscal year of 2009 and 2013, FedEx has grown annual revenues by a cumulative 28% to $44.3 billion. Earnings rose by 32% to $1.56 billion in the meantime.

Investment Thesis

The company remains committed to its long-term profitability targets. The Express division is still committed to boost operating profits by a cumulative $1.6 billion by the end of the fiscal year of 2016. While the unit is by far the largest in terms of revenues, it lags in profit contributions despite margin improvements over the past quarter.

Continued cost cutting efforts at this unit should bolster overall profitability as customers cut back from expensive airfreight shipping options, and fuel surcharges are under pressure. The star performer within the company remains the ground business which reports really fat profit margins.

Yet the real profit improvements are not seen in the fiscal year of 2014 yet, despite the projected earnings increases. The real improvements will be seen in 2015 when fleet modernization, cost controls and lay-offs will really start to make an impact on the bottom line. Note that roughly half of the 3,600 workers which were made redundant have left the company at this point in time.

FedEx remains a bellwether as it handles over 10 million packages a day across the globe, giving the company unique insight in the strength of the global economy and changing trends. Continued cautious words from the company should be taken seriously as it calls the current situation the "new normal."

Back in March of this year, I last took a look at FedEx's prospects. I concluded that investors were negatively surprised by the continued Express troubles which sent shares to $100 at the time.

The cumulative profit improvement target of the Express division for 2016 should boost annual earnings by some $500 million per annum, thereby boosting earnings per share by some $1.50. The company notes that it is ahead of schedule in achieving these cost reductions in its conference call.

With adjusted earnings estimates around $7.00 at the high end of the range for 2014, earnings could improve toward $9.00 per share if cost benefits materialize and the global economy remains on track by 2016. Further investments in the Ground business, which generates high returns on assets, will be a driver of future earnings, so will lower operating earnings in Freight. The fleet renewal driven by Boeing's (BA) 767-300 freight planes are reducing operating costs markedly.

Shares trade at 17 times projected earnings for the coming year and about 13 times projected earnings in two year's time given that improvements materialize as anticipated. These are relatively attractive multiples, although I'm disappointed with the lack of dividends.

I remain on the sidelines.

Source: FedEx: On Track With Cost Reduction Targets