- Shares of FedEx are undervalued by 12%.
- The trend towards e-commerce, across the retail landscape, will increase the volume of goods requiring transport, and drive sales growth higher.
- Fair value indicated at $167/share, with an implied terminal EBITDA multiple of 6.70x.
FedEx Corporation (NYSE:FDX) provides transportation, e-commerce, and business services domestically and internationally. The Company operates in four business segments: FedEx Express, FedEx Ground, FedEx Freight, and FedEx Services. The profitability of FedEx is directly linked to the state of the macroeconomy, as periods of global growth drive demand in the highly cyclical transportation industry. Conversely, periods of either anemic or sedated economic activity pose a significant risk to revenue generating capabilities.
In that the volume of goods being produced and consumed dictates the volume of goods requiring transport, FedEx can conceivably be looked at as a global growth watchdog, a stock that should oscillate according to the economic outlook. Not only growth in developed markets, but also in emerging markets. As FedEx continues to expand across Latin America, Europe, and Africa, the heightened emerging market exposure will ideally diversify country-specific risk, and augment long-term profitability. An increasingly desirable economic climate, and positive improvements in the overall health of the consumer, are essential for yielding top-line growth.
These conditions met, a developing trend in the way that consumers are spending may also have positive implications for FedEx in the years to come. As more customers forego the brick and mortar shopping experience, and instead gravitate towards online retail, FedEx stands to profit from the expanding e-commerce space, and a transforming retail landscape. Below, the price of FedEx is displayed along with the Consumer Credit Report, and the Consumer Price Index. Both economic indicators are intended to reflect the health of the American consumer, and here, highlight the tendency for shares of FedEx to rise in accordance with economic activity, over the long-term.
Commodity Risk: Fuel
The price and availability of fuel is inextricably linked to the operating profitability of FedEx's extensive transportation network. An increase in the market price for fuel necessitates the implementation of indexed fuel surcharges. These surcharges are intended to alleviate any correlative expense impact of rising costs, as they relate to the operation of aircraft and vehicles. However, there exists a danger that higher surcharges will push customers away from the higher-yielding express services, and consequently drive demand towards lower-yielding, deferred or ground services. This commodity risk management surcharge does not fluctuate with whiplash delta sensitivity, rather, changes in the surcharge lag the price of fuel by six to eight weeks. In this respect, we can look at the price of fuel today as a metric by which to gauge the demand for higher yielding services, and estimate operating profitability over the near-term. With the October '14 contracts of Brent Crude futures currently trading around the 102/101 level, off of mid-June highs with a 113 handle, one can speculate that there will be a material increase in the demand for express services, and that lower fuel costs will stimulate FedEx's forward operating profitability. In order to explore this relationship, the daily spot price of Brent Crude oil, as measured by the United States Brent Oil Fund (NYSEARCA:BNO), is plotted against the daily price performance of FedEx, over a one-year period, on the chart below.
Both numbers are adjusted for beta so as to isolate the correlational component from broad market volatility. The correlation coefficient of -0.33 reflects a moderate negative relationship, so that as the spot price of Brent Crude has fluctuated over the past year, the price per share of FedEx has tended to react inversely. While the statistical significance of this number is arguable, it underlines the potential for commodity risk to impede significant price appreciation down the line.
Currently trading at 7.45x EV/EBITDA, shares of FedEx look undervalued relative to the delivery services industry average 10.91x EV/EBITA, trailing twelve months. The charts below demonstrate the sensitivity of the total equity value to changes in the forward revenue growth rate, and illustrate the corresponding free cash flow, and EBITDA growth projections. The FCF and EBITDA growth forecast is determined using the consensus revenue growth rate, indicated below.
A fair value estimate of $167/share is derived using the perpetuity growth method, where the terminal perpetuity growth rate is 3.0%, and the discount rate is 11%. Assumptions include $1828mm net debt, and 285.4mm diluted shares outstanding. Sensitivity analysis for the total enterprise value, total equity value, implied terminal EBITDA multiple, and price per share is provided below.
Shares of FedEx look to have 12% further upside from here. A long position initiated at current levels would yield a risk adjusted return of 2%, at fair value. Bottom line, FedEx is a buy if you're bullish on the U.S. economy.