FedEx Corporation - Profit Improvement Plan Is Not Enough

by: Ernestas Petraitis

Summary

Courier companies that deliver goods to the final recipient will benefit from an increase in e-commerce.

E-commerce will grow faster than the global GDP. The cross-border e-commerce will grow even more quickly.

The US market is dominated by two companies – UPS and FDX.

FDX profitability is far below UPS because of much higher sales, general and administrative expenses.

FDX is not ambitious enough in increasing the profitability even taking into account current $1.7 billion profit improvement program. Additional $3.5 billion improvement plan should be put in place to put it in line with UPS.

It was reported in December, that spending in physical stores fell by 10 percent from last year on both Thanksgiving Day and Black Friday while the online sales were up by double digits. E-commerce takes the bites on the brick and mortar stores because of the convenience of shopping. Why spend the valuable time traveling to the shop, hustler for the goods and carry them home if everything could be done sitting comfortably at home with quick delivery at home.

I do not advocate for investing in the Amazon or other e-commerce companies but want to look to the companies without which e-commerce could not be performed in an efficient manner. Those are the courier companies that deliver the goods to the final recipient. Those companies will benefit a lot.

According to the IBISWorld research, the US market is dominated by two companies - United Parcel Services with 38.9% market share, followed by FDX with 26.6% market share. Combined these two companies have 65% of the US market. It is expected that e-commerce will grow faster than the global GDP growth rate. The cross-border e-commerce will grow even more quickly.

Let us compare both of them.

FDX provide transportation, e-commerce and business services through FedEx brand companies: FedEx Express (express transportation company, 53% of sales and 51% of Operating Profit), FedEx Ground (small package ground delivery services, 32% of sales and 47% of Operating Profit), FedEx Freight (less-than-truckload freight services, 13% of sales and 10% of Operating Profit) and FedEx Services (provides direct and indirect support to transportation businesses).

Currently, FDX is in the process of acquiring the TNT Express - a public limited liability company domiciled in Amsterdam, the Netherlands, for approximately €4.4 Billion or roughly 9.7x the median expected the fiscal year 2015 EBITDA of EUR 407 million of TNT Express. TNT Express operates in the Courier, Express and Parcel market and collects, transports and delivers documents, parcels and palettes freight on a day-definite or time-definite basis. Its services are primarily organized by the speed, distance, weight and size of consignments. The majority of its shipments are between businesses (B2B).

On 8 January 2016, the unconditional approval for the merger was provided by the European Union regulators. This message gives a positive signal that the merger will eventually happen, and now it is clear that similar situation as happened with UPS acquisition of TNT Express in 2013 will not be repeated. It should be noted that still some regulatory approvals (e.g. from China and other countries) are to be issued this year. The merger, if finalized, would allow FDX to expand their services in Europe and immediately lift the overall sales amount (TNT Express has revenue around €6.8 Billion).

Clearly, a lot of works needs to be done to integrate TNT Express into FDX and to increase the profitability because current operating and net income ratios are inferior to the FDX.

UPS is the world's largest package delivery company that provides services in 220 countries and territories. Total revenue in 2015 financial year it is expected to reach 58.6 Billion. The company's operations are broken into three segments: U.S. Domestic Package (62% of sales and 63% of Operating Profit), International Package (21% of sales and 28% of Operating Profit) and Supply Chain & Freight (16% of sales and 10% of Operating Profit). The analysis of the quarterly report for the period ending 30 September 2015 shows that revenue grew (by 2%) only in U.S. Domestic Package business and decreased in other two segments. Interestingly, the operating profit increased significantly in all the segments (by 44%, 16%, and 26% respectively).

Profitability

Profitability

UPS

FDX

Gross Margin

78.80%

88.50%

Operating Margin

10.90%

4.10%

Net Margin

6.81%

2.30%

Cash-Flow/Sales

13.7%

11.7%

Click to enlarge

Looking for the profitability, it seems that UPS has higher Operating and Net Margins even though FDX has better Gross Margin. The reason for that is the following: FDX sales, general and administrative expenses (64.96% vs. 54.48% for UPS), depreciation and amortization expenses (5.37% vs. 3.5% for UPS) and the other costs (14.03% vs. 9.86%) are much higher than for UPS. To illustrate that, the total operating expenses of FDX are more of the same as for UPS in dollar terms, but they have 10 Billion less in revenue. Therefore, FDX has a lot of work to do.

In 2012, FDX announced the three-year profit improvement program to increase annual profitability by $1.7 billion over the next three years. In 2015 annual report, the FDX management stated that they've already achieved 70% of the plan. Though, it is not very clear whether these achievements are achievements, o just a luck of driven by lower fuel prices and currency exchange rates.

According to my understanding, FDX is not ambitious enough in increasing the profitability. The profit improvement program is the right thing to do, but is it in the absolute terms and linked to the year 2013 results, but not to the percentage of the sales. If 70% of the plan is completed, the results do not show big impact. FDX is still far below the profitability of UPS.

Valuation

Valuation

UPS

FDX

Share Price in $

90,02

126,92

Market capitalization, Billion $

82,0

35,4

12 month trailing PE

20,7

32,4

Price / Sales

1,4

0,7

Price / Book Value

42,5

2,4

Price / Cash Flow

10,3

6,2

Click to enlarge

Estimates

UPS

2015

2016

2017

EPS estimates (calendar year) in $

5.29

5.76

6.33

EPS growth rate

11.3%

9.0%

9.8%

Stock price using min P/E of five years (12.9x)

68.24

74.30

81.66

Stock price using average P/E five 5 years (16.8x)

88.87

96.77

106.34

8%

Click to enlarge

FDX

2015

2016

2017

EPS estimates (calendar year) in $

9.89

11.38

12.64

EPS growth rate

23%

15.1%

11.1%

Stock price using min P/E of five years (13.0x)

94.94

109.25

121.34

Stock price using average P/E five 5 years (22.0x)

142.42

163.87

182.02

16.3%

Click to enlarge

Conclusion

Looking at the EPS estimates, it seems that market expects the FDX to deliver better EPS growth than UPS, and that is reflected in the valuation. However, a lot depends on the execution by FDX management to achieve the results and successful integration of TNT Express, which has showed worse results than FDX.

The $1.7 Billion profit improvement plan is not enough. An additional $3.5 billion improvement plan should be put in place to put FDX in line with UPS. If an investor believes that FDX will be in line with expectations, the potential return is better for FDX. Myself, I doubt that without additional or new profit improvement plan, FDX will match UPS in the short term.

According to me, UPS is a better business and provided better value than FDX at this point.

Disclosure: I/we 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.