FedEx Earnings Preview: Stock Approaching Full Valuation; Requires Volume Growth

| About: FedEx Corporation (FDX)

FedEx Corporation (NYSE:FDX) reports their fiscal 2nd quarter, 2014 earnings before the opening bell on Tuesday, December 18th, 2013, with analyst consensus looking for $1.63 in earnings per share (EPS) on $11.43 billion in revenues for expected year-over-year growth of 17% and 3% respectively.

Analyst consensus estimates for the 2nd quarter '14 have remained relatively stable since the September '13 earnings release, where consensus for q2 '14 was expecting $1.62 and $11.440 billion in revenues.

The big news in the last year for FDX was the announcement of the 32 million share repurchase program on October 15, 2013, which pushed the stock from the $114 - $115 price area into the low $130's where FDX trades today.

Thirty-two million shares is roughly 10% of FDX's 319 million fully-diluted shares outstanding as of the 8/31/13 quarter end, so the buyback is material from an EPS perspective.

The many SeekingAlpha readers which populate the site can have varied and different time horizons, from a trading or investing perspective. We tend to be long-term investors for client portfolios, and have combined a blend of value and growth investing within the accounts.

Our oldest position in FDX is from March, 2000, with a $36 cost basis. Since then, within most client accounts, we have traded the stock, and have done pretty well for clients in terms of FDX's total-return. (Fundamentally, our internal spreadsheet goes all the way back to February, 1998, which is a 15 year history of FDX's financial results.)

Over the last 10 years, FDX has struggled with volume growth, particularly in Express, where, according to one analyst (can't recall the source), Express volume had not grown or even contracted, for 6 of the last 7 years ended May, 2013.

FDX Express is 60% of FDX's total revenues, but just 30% of its operating income last quarter, so the negative leverage for a key business is easy to see.

FDX Ground on the other hand is the exact opposite story for FDX: Just 25% of FDX's total revenues, Ground accounts for 50% of FDX's operating income, and the Ground segment has been generating positive volume growth with good yields since the inception of the segment in 2000.

Here is a brief table on the breakdown of FDX's revenue and operating income by segment:

FDX's rev's and operating inc by segment - last 4 quarters
FDX Rev's q1 '14 q4 '13 q3 '13 q2 '13
* Express 60% 61% 61% 62%
* Freight 13% 12% 11% 12%
* Ground 25% 24% 25% 23%
* Services 3% 4% 3% 4%
*Other -1% -1% -1% -1%
Total FDX Rev 100% 100% 100% 100%
FDX Op inc
* Express 30% 0% 20% 32%
* Ground 59% 92% 79% 57%
* Freight 11% 8% 1% 11%
* Services 0% 0% 0% 0%
* Other 0% 0% 0% 0%
Total FDX Op Inc 100% 100% 100% 100%

FDX has embarked on a cost-cutting initiative within Express that has reduced headcount and downsize the unit so that the fixed-cost structure is appropriate for a low-single-digit volume growth rate within Express.

The plus side to that is any improvement in volume at Express, if and when it should ever occur will drive better EPS growth, as FDX Corp has taken fixed costs out of the Express P/L, thus more revenues will get to the bottom line.

The last year there has been a "trade-down" effect at Express as SouthEast Asian customers have gravitated to lower-cost freight options, presumably shipping and container, versus airfreight.

In the meantime, Ground continues to execute well. The segment has been a stalwart as Express and Freight have languished, with mid to high single digit volume growth rates and good yields.

Whether it was the DHL exit from the U.S. market, or some other factor, a price war hasn't developed between FDX and UPS (NYSE:UPS) in the Ground segment. The competition is very rational and yields have remained healthy allowing both companies to continue to maintain margins.

FDX's valuation on a p.e basis seems normal at 19(x) and 15(x) forward earnings for 2014 and '15 of $7.01 and $8.84, and given the expected EPS growth in fiscal '14 and '15 of 13% and 26% the next two fiscal years.

Price to cash-flow is 8(x), which is about right for a highly leveraged business, with price to free-cash-flow (NYSE:FCF) of over 20(x), which is why the share buyback kind of surprised me.

To repo the 10% of the shares outstanding, FDX needs to generate more free-cash-flow. As of the Aug. '13 quarter, FDX's FCF was $1.8 billion (4-quarter trailing) which at the time of the report, meant FDX could repo 15 million shares, and that is if ALL the free-cash went to the repo, which it can't, since FDX pays a dividend.

The share repo will likely take a few years to conclude, unless FDX adds to the $3 billion in long-term debt outstanding, which they could do.

In terms of intrinsic value, our internal model values FDX near $150, while Morningstar has a current "intrinsic value" on FDX of $125.

Technically, a pullback to the February, 2007 high of $121.42 would likely be a good place for technical support of the stock, and a place to buy for a trade.

What would likely need to happen to see an upward bias to intrinsic value of FDX ?

1.) Continued decline in crude oil prices and jet fuel, which if the surcharge is still in place, adds to FDX's bottom line. Of course the opposite is true as well;

2.) Reinvigorated Express volume, which would mean the segment would see volume growth rise from the -2% to 3% range, solidly into mid-single-digits. That isn't out of the question given the recovery in Japan, and China, but I do believe we would need to see a prolonged streak of decent GDP growth in the global economy.

3.) Jeff Bezos' shot across the bow with the drones and same-day delivery, was in my opinion a direct shot at FDX and UPS. Same day delivery is coming, and many retailers and will evolve to provide that service for customers. FDX and UPS could benefit from this I would think, over the long run, but they would need to do it in a cost-effective manner;

4.) Probably less well understood and maybe a smaller impact is the SP 500 returns in 2013 as well as higher interest rates, both of which impact pension benefit obligations positively. FDX could see some savings on pension expense given their union workforce, although to be honest I haven't run the math on this in years, and with the shrinkage in the Express workforce, this may become less of an issue in the future.

To conclude, FDX is approaching full valuation given the current state of the world, but the p.e-to-growth ratio's on the stock for the next two years are pretty reasonable, and faster global growth would be a definite plus.

Disclosure: I am long FDX, AMZN. 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.

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Tagged: , Air Delivery & Freight Services, , Earnings
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