Investors in FedEx (NYSE:FDX) have had a great run this year amidst improved operational excellence, higher revenues and shareholder-friendly initiatives. After this great run up analysts at multiple research firms boost their recommendation for the shares ahead of the second quarter results as reported on Wednesday.
I believe analysts might be jumping on the bandwagon a bit late, and would not chase shares up at this current level. I remain on the sidelines.
Second Quarter Results
FedEx generated second quarter revenues of $11.40 billion, up 2.7% on the year before, slightly missing consensus estimates at $11.44 billion.
Net earnings rose by 14% to $500 million as earnings per share rose by 13% to $1.57 per share. Note that last year's earnings included a $0.11 per share charge on the back of the impact of superstorm Sandy. Earnings came in a little short of estimates, with analysts looking for earnings of $1.64 per share.
The strong earnings growth was driven by solid operating margin expansion, with margins increasing by 80 basis points to 7.3% of total revenues.
The express segment reported flat revenue growth, yet the margins saw a big boost. Revenues came in at $6.84 billion, while operating margins rose by 140 basis points to 4.8% of total revenues. Cost reduction efforts, higher package yields and lower pension expenses boosted margins.
The ground business reported a solid 10% growth in revenues to $2.85 billion. Margins saw some pressure falling by 100 basis points to 14.9% of total sales. The continued growth in e-commerce boosted revenues, while margins fell on the back of a later start of the holiday shipping season.
The freight business reported a 4% increase in revenues to $1.43 billion. Margins were essentially flat at 5.4% of total revenues.
Analyst Are Bullish
At the end of last week, analysts upgraded FedEx already ahead of the second quarter earnings report, citing further potential for cost cutting and revenue growth.
Analysts at Raymond James upgraded FedEx as the company is set to deliver further gains. Analyst Arthur Hatfield upgraded FedEx from "Outperform" to "Strong Buy". Hatfield attaches a 12-month price target of $190 per share, suggesting some 38% upside from Friday's closing levels last week.
There is more value in the shares on the back of the aggressive cost improvement plans which are in progress and are on track according to Hatfield. Given the aggressiveness and the relative transformative plan, the stock should be trading less on current earnings power, but more on the back of earnings power a few years down the road.
Actually it is not just analysts at Raymond James which are bullish. Citigroup attached a $170 price target to the shares as well. Cost efforts at the express segment, higher volumes and share buybacks should drive future earnings. Earnings of $10 per share should "enter the discussion" in 2015, which combined with historical multiples of 17 times earnings explains the price target.
The company ended the second quarter of its fiscal 2014 with $4.0 billion in cash and equivalents. Total debt stands at $3.0 billion for a net cash position of around $1.0 billion.
Revenues for the first six months of the fiscal year of 2014 came in at $22.4 billion, up 2% on the year before. Net earnings rose by 10% to $989 million. At this pace, annual revenues are seen around $45 billion, while earnings could increase towards $2.2 billion.
Trading around $140 per share, the market values FedEx at roughly $44 billion, which values operating assets of the firm at $43 billion. This values operating assets of the firm at little below 1.0 times annual revenues and 20 times GAAP earnings.
FedEx currently pays a quarterly dividend of $0.15 per share, for an annual dividend yield of 0.4%.
Some Historical Perspective
Long-term investors in FedEx have seen modestly solid results, driven by the run up of the shares into 2013. Shares fell from highs of $120 in 2006 towards lows of just $40 in 2009.
Shares mostly traded in a $70-$100 trading range following the recovery. Since the start of the year, shares have risen by about 50% to current levels approaching $140 per share.
Between the fiscal year of 2010 and 2013, FedEx has increased its annual revenues by a cumulative 27% to $44.3 billion. Earnings rose by about a third to little above $1.5 billion last year.
Sophisticated Investors Buy The Growth Story
Recently FedEx has attracted some prominent investors. Dan Loeb who runs Third Point LLC has recently bought a 2 million shares stake in the business. Loeb aims for a more shareholder friendly capital structure, accompanied by higher dividends, given FedEx's paltry dividends at the moment. Loeb might also be involved with the succession planning of CEO and Chairman Fred Smith, after he recruited Marissa Mayer for Yahoo (NASDAQ:YHOO).
Other recent investors include Soros Fund Management, the fund behind Georgo Soros which bought a 1.5 million share stake in the firm. Despite these prominent investors, large changes are unlikely. FedEx already announced share repurchases and a cost reduction program. There is more room however for further dividend hikes given the solid earnings, strong capital structure and low current dividend yield.
Perhaps these "sophisticated" investors are attracted to FedEx given its strong exposure to the growing e-commerce. The company previously expected to make 19 million shipments on December 10, which is going to be a peak day. Between Thanksgiving and Christmas the company expects to ship 280 million packages. This projection sees shipments up 13% on the year, on the back of continued growth in e-commerce shopping, requiring FedEx to hire a staff of 20,000 on a temporarily basis to handle all these additional flows.
Investors are pleased with the progress of FedEx which is targeting massive improvements at the Express business.
The express business generates the vast majority of the revenues, some $6.85 billion in the second quarter of the fiscal year of 2014, roughly unchanged from last year. The unit generated operating earnings of "merely" $326 million, for operating margins of 4.8% which was up already 140 basis points compared to last year. In total, FedEx targets $1.6 billion in operating earnings improvement for this business, boosting margins towards 10%.
The ground business continues to drive the results, and notably earnings on the back of the growth in e-commerce. Revenues came in at $2.85 billion, up 10% on the year before. The unit generates the vast majority of earnings of $424 million, with high operating margins of 14.9%.
The ambitious targets to boost operating margins towards 10% of total revenues, could result in annual operating earnings of about $5.0 billion by the fiscal year of 2016. This could boost GAAP earnings to $3 billion per annum by the fiscal year of 2016, valuing the business at 14 times earnings at the time.
For now, FedEx is already making progress, as the business has a great reputation for achieving long-term market share gains. The 3.9% to 4.5% price hike target for its business in January of 2014 will boost earnings in the immediate term as well. On top of that, the company aims to repurchase 32 million shares, which at a current price could cost the company upto $4.5 billion. Given the solid financial position, this should provide no problem for the balance sheet. During the second quarter, FedEx actually repurchased 7.2 million shares, or 2.3% of its current float which is quite aggressive.
Back in September, when FedEx reported its first quarter results, I last took a look at the company's prospects, as I concluded to remain on the sidelines despite the attractive valuation multiples on the back of low dividends. Ever since, shares have risen about 25% in just three month's time, raising the expectations for the second quarter results later this week. Real improvements will come later this year and into next year with fleet modernization, lay-offs and cost controls making a real impact on the earnings.
While earnings of $10 per share in 2016 might be realistic, this still values the business at around 14 times earnings two or three years ahead. Given the big run-up in recent times, it seems that analysts are running behind the bandwagon, as I would be much more cautious at current levels.
I remain on the sidelines.