The year 2013 was another good year for FedEx (NYSE:FDX) bulls with a stock price appreciation of 53%. The company has been rated overweight by big financial service firms like Citigroup and Deutsche Bank due to its strong fundamentals and bright growth prospects. Going forward, can the company continue its bull run?
Driving factors for FedEx in 2014
FedEx might look overvalued for 2014, but there is more upside potential stemming from the company's initiative and overall market growth, especially from e-commerce. E-commerce is the biggest growth driver for the company with worldwide e-commerce sales expected to hit $1 trillion in 2016, representing 1% of the overall global GDP. U.S. online spending is expected to increase from $262 billion in 2013 to $371 billion in 2017. In the last decade, FedEx launched initiatives focused on the e-commerce market like FedEx Home Delivery (the first dedicated residential delivery service) and FedEx SmartPost (provides an economical option to online retailers for shipping lightweight products at low cost). FedEx SmartPost has played a major role in FedEx's growth in the e-commerce market as this service has been popular among online retailers for providing free shipping. Around 50% of online sales come with free shipping, and this has resulted in strong demand for FedEx SmartPost, which is boosting FedEx's ground segment.
Average daily package volume
This trend has continued in the second quarter of fiscal year 2014. SmartPost's average daily volume increased 9% year over year. Going forward, the ground segment revenue growth will sustain this year due to demand from e-commerce supported by the increased shipping rate in the ground segment, including SmartPost, effective from January 6, 2014.
FedEx's ground segment helped the company offset the decline in the FedEx express segment in the last quarterly result. FedEx Express is the premium next-day air service provided by the company, but a shift in the trend towards the demand for slower and cheaper shipments services has adversely affected the segment's revenue thereby putting pressure on the margins.
In October 2012, FedEx had laid out the profit improvement program to reduce operating cost to boost profit by $1.7 billion by fiscal year 2016. Most of the restructuring is occurring at the FedEx Express division with fleet modernization, replacing the existing fleet of Boeing 727s, MD 10s and MD 11s with newer, more-fuel-efficient aircraft including Boeing 757s and 767s. Boeing 757s are a 20% cost improvement and the Boeing 767s are a 30% cost improvement compared to the company's existing fleet.
In December 2013, FedEx placed an order for two new 767-300F freighters from Boeing, adding to the initial order of 50 new 767-300F freighters. Boeing delivered the first 767-300F freighter in September 2013, and the remaining planes are expected to be delivered through 2019. Fuel expenses as a percentage of the total revenue of the Express segment is currently pegged at 14.5% (second quarter of fiscal year 2014). Therefore, this percentage will come down going forward. FedEx Express is the company's biggest segment with 61% share in total revenue for fiscal year 2013. Therefore, these cost reduction initiatives positively impact the company's overall margin as well as the segment's margin.
These initiatives were targeted from the cost perspective, while also boosting the express segment's revenue. Additionally, the company is actively pursuing international market opportunities. International revenue forms 45% of the FedEx Express revenue (for fiscal year 2013), so it is an important source for the segment's growth.
FedEx is also streamlining the organization by removing redundant jobs. In June last year, FedEx completed a voluntary buyout program to reduce human personnel by 3,600, helping it reach the target of achieving a $1.7 billion profit boost by its fiscal year 2016.
Overall FedEx is all set to post a strong result in 2014. The positive macro environment (increase in consumer spending) and strong demand from e-commerce will be significant growth drivers for the company. In addition, improving overall margins, mainly contributed by FedEx Express segment, will also promote strong profitability.
How UPS might affect FedEx's growth in 2014?
Like FedEx, UPS (NYSE:UPS) has also been a beneficiary of the e-commerce boom, and its air services' margins have also been affected by the changing consumer trend to shift to cheaper ground services rather than faster and expensive air services.
UPS has taken bold initiatives towards e-commerce, and due to its leading position in ground logistics, the company was the beneficiary of the consumer shift towards cheaper ground transportation while FedEx, being more inclined towards the air-based delivery system, was adversely affected by this trend. However, FedEx has implemented key initiatives to increase its presence in ground logistics and reduced FedEx Express costs to remain competitive in the market.
In the e-commerce market, UPS has an important partnership with Amazon (NASDAQ:AMZN). During the third week of December, Amazon added 1 million new Prime customers, and a staggering 36.8 million items were ordered from the website on Cyber Monday alone. This is a record membership set during the holiday season for Amazon Prime, with its annual membership program offering free two day shipments on its items. Therefore, UPS benefited significantly from having Amazon as a partner. In addition, UPS had also launched a Mobile App for the Amazon Kindle Fire Family that allows customers to manage their delivery packages.
On the cost side, UPS has improved its margin, thus operating as an industry leader with operational margin of 13.7% for the first nine months of 2013. The key initiatives towards this involved speeding up the deployment of On-Road Integrated Optimization and Navigation, or ORION software, which optimizes delivery routes to reduces miles driven. The company plans to deploy this software to nearly all 55,000 routes by 2017. A reduction of one mile per day saves cost up to $50 million annually in expenses, so full deployment of this software across all routes will bring significant cost reduction. UPS is also aiming to shift towards natural gas and announced plans to purchase 700 LNG vehicles and build 13 fueling stations by the end of 2014. UPS has noted that shifting towards LNG will result in savings of 24 million gallons of diesel fuel annually.
Therefore, the industry leader will affect FedEx's growth plans, and it will be difficult for FedEx to gain market share in light of the stiff competition. FedEx has been working hard to remain competitive in the market, so it will be interesting to see which company benefits the most and gains traction in the logistics market.
FedEx's growth fundamentals look solid, and after its cost initiatives, the company will have high profitability to return to shareholders. FedEx has always provided good shareholder returns in terms of share repurchase, and during October of last year, the company authorized another share repurchase program for 32 million outstanding shares of common stock, thus augmenting the 7.4 million shares left in the previous authorization. From the investment point of view, FedEx looks relatively undervalued compared to its peer based on its trailing twelve months P/E 27.18X and Price to Sales ratio of 0.97 compared to UPS's forward P/E of 66.81x and P/S ratio of 1.72, which indicate that FedEx still has upside potential.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.