Can FedEx Deliver Impressive Returns?

| About: FedEx Corporation (FDX)

Summary

FedEx Express could be under pressure as the global economy slows.

FedEx determined to improve operational efficiency.

FedEx is expensive and could be a risky play if a recession is in the cards.

FedEx Corp (NYSE:FDX) has had flat year, as the stock took a dip earlier this year, but has since rebounded to where it started. FedEx is dividend into four primary segments: Express, Ground, Freight and Corporate Services. The FedEx Express segment accounts for over 57% of its revenue, as it delivers expedited packages to customers in over 220 countries, with approximately 4 million shipments per day. FedEx is set to report Q4 2016 numbers tomorrow and it could be the start of a sustained rally back to historical highs. There's no question the global economy has slowed and FedEx has done everything possible to weather the storm, so that it could stay on track with its full-year guidance and earnings expectations. I believe FedEx is a fantastic business, but if a recession is indeed coming, then FedEx will get hit very hard.

FedEx Express could be under pressure as the global economy slows

FedEx express is the biggest contributor to the company's revenue stream, as we head into the latter part of 2016, we may see the $1.7 billion investment in the profit improvement program finally work its way into the financials through improved operating margins. FedEx CEO Fred Smith estimates a 12% operating margin for the express segment, as the profit improvement program makes FedEx more profitable in the long-term. With the global economy showing signs of weakness, we may see customers opting to go for cheaper, slower methods of delivery, which implies a decline in revenues from FedEx's biggest segment. If a recession is indeed in the books for the next few years, FedEx's express division may see a huge drop in sales, and we could see FedEx's stock take a gigantic hit. UPS has enjoyed next-day-air delivery growth over the last year, which is a great sign for FedEx's express segment, and we may see even better numbers, as it looks like the global economy may be slowing, but it is most likely not dead yet.

FedEx determined to improve operational efficiency

FedEx had a poor average operating margin of 8.6% and net margin of 2% over the last year and there's no questions that FedEx is determined to turn this around in order to unlock value for the long run. That's why management decided to invest in the profit improvement program three years ago. Another part of this initiative to improve operational efficiency is coming from requiring its customers to package more efficiently, to save volume when transporting packages. In the last quarter, FedEx introduced weight pricing and oversize-shipment surcharges, which will penalize its customers for not packing their parcels in the most efficient manner. Such initiatives will drive long-term margins, as the initiatives will both allow for more carloads to be moved when parcels are efficiently packaged to save volume, as well as adding directly to FedEx's bottom-line when a fee is charged to a customer who is not packaging in the most efficient way. FedEx has invested in dimensional scanners, which will help provide costs for its parcels, and in the long run I see this investment paying off very fast. It's small initiatives like these which allows FedEx to rise head and shoulders above competition, and it is what will allow FedEx to drive their margins and boost profitability for long-term shareholders.

Valuation and Conclusion

FedEx depends on growth in the economy in order to strive. While management can't do anything about the global economy, it can take the initiative to drive its margins and improve its own operational efficiency, so that it can be more profitable in great economic times, as well as a slowed economy like the one we're in right now. FedEx has a great operational efficiency improvement strategy in place, and it will help boost its operational cash flow, which is currently at an impressive 2.6x net income. FedEx is not cheap right now, as it has a 45.9 P/E and a 3.0 P/B, both of which are higher than their five year historical average values of 21.8 and 2.4 respectively. The dividend yield is nothing to write home about at a less than impressive 0.7%. Even with management's efforts to drive profitability for the long run, I cannot recommend buying shares of FedEx right now because of its very expensive valuation, and considering the fact that we may be entering a global recession, with slowed growth currently across the board. If a recession does indeed happen, FedEx could drop -70% like it did during the last recession. I would tread carefully, and only consider FedEx if the global economy starts to show signs of strength.

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.