FedEx: Margin Expansion Will Deliver EPS Growth

| About: FedEx Corporation (FDX)
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Even with the global economy slowing down, FedEx has reaffirmed the EPS guidance for FY15.

Lower fuel cost is one of the important margin expansion factors in the coming quarters.

Fleet renewal in 2015 and 2016 will also contribute to long-term margin expansion.

FedEx looks attractive from a forward PE perspective and the company's focus on high margin and high ROIC ground business will deliver value for shareholders.

FedEx Corporation (NYSE:FDX) has seen a strong year with the stock surging by 21.3% YTD. I believe that the rally for FedEx will continue into 2015 and this article discusses some of the key reasons to remain bullish on FedEx. While the company's financial results have been discussed in details in few other recent articles in Seeking Alpha, I will focus on a few finer aspects of the results and the growth drivers.

One of the major positive factors for FedEx is the recent decline in oil prices. The decline in oil prices has impacted the company's margin in 2Q15 and will continue to impact the key margins over the next few quarters.

To put things into perspective, FedEx's fuel cost for the second quarter of 2015 was 8.8% of the revenue as compared to the fuel cost being 10% of the revenue in the second quarter of 2014.

The key point here is that the global economy is weakening and there is a supply glut of oil. The implication is that oil prices can remain in the range of $60 to $70 per barrel in the coming year. Therefore, the benefit of lower fuel prices will continue for FedEx.

An important point related to the global slowdown and fuel cost is the company's EPS guidance for 2015. FedEx has reaffirmed an EPS guidance of $8.5 to $9.0 per share for 2015. The guidance has been reaffirmed even after a slowdown in the global economy as is clearly evident from the chart below.

Therefore, it is interesting that the EPS guidance has been reaffirmed even with the global economy slowing down. There are two reasons for the reaffirmation of EPS guidance -

  • First, any impact of global slowdown on revenue will be offset by margin expansion on lower fuel cost and this will keep the EPS robust
  • Second, FedEx plans a capital expenditure of $4.2 billion in 2015. The company's capital expenditure is focused on fleet modernization. In terms of trip cost, the company's December 2014 presentation projects a 20% cost reduction in using the B757 fleet and a 30% cost reduction in using the B767 fleet. As the new fleet is operational, the company's key margins will get a further boost in the coming quarters.

From a margin perspective, I want to add here that the company's operating margin has improved to 8.5% in 2Q15 as compared to 7.3% in 2Q14. The company's long-term goal is to achieve an operating margin of 10% and I believe that this is possible with fuel efficient fleet coming in 2015 and 2016.

Besides the margin expansion that is likely to come from renewal in fleet, the company's operating margin is also likely to benefit from bigger investment in the higher margin and higher ROIC ground business. Further, the recent acquisition of Bongo International, which increases the company's e-commerce segment, is also positive for margins over the long-term.

Therefore, from a margin expansion perspective, FedEx is making the right moves and I expect the company's EPS to get a boost on higher operating margin besides the impact of higher revenue.

From a valuation perspective, FedEx expects an EPS of $8.5 to $9.0 for the current year. If the mid-range of the guidance is considered, an EPS of $8.75 is likely in the current year and FedEx is therefore trading at a 2015 PE of 19.9.

Further, FedEx expects EPS growth to be in the range of 10% to 15% over the long-term. While the company's EPS growth for the first half of 2015 has been 37%, even if an EPS growth of 15% is considered for FY16, the likely EPS will be $10 and FedEx is trading at roughly 17 times FY16 EPS.

I believe that these valuations are attractive considering the strong margin expansion and growth plans lined-up. I therefore believe that FedEx will continue to trend higher and investors can consider exposure to the stock at current levels.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.