FedEx (NYSE:FDX) is the world's largest express transportation company. Having acquired TNT Express this year, FedEx strengthened its market position and invigorated its investors. Below, I will elaborate why you should hold shares of FedEx after their 29% rally since the start of 2016 (see Picture 1). For this purpose, I will analyze the company's financial position, and then I will estimate the target price of its shares.
Source: Yahoo Finance
Financial Position Analysis
Based on information from Picture 2, we can observe the following:
- Since 2010, revenues of FedEx have been growing steadily with a CAGR of 6.4%. A 6% revenue increase in 2016 was driven by the strong performance of the Ground segment, which consolidated the results of GENCO, a leading North American third-party logistics provider acquired in January 2015. After the first six months of 2017, FedEx reported a $4.9bn year-on-year sales increase, attributed to consolidated financials of TNT Express, a Dutch express transportation company. The company was acquired in May 2016, five days before the end of the last fiscal year.
- It would be misleading to analyze the development of reported operating margin, since in the last two years, it was largely affected by retirement plan adjustments ($1.5bn in 2016 and $2.2bn in 2015) and impairment charges ($280m in 2015). On an adjusted basis, operating margin has been increasing over the last three years (from 8.4% in 2014 to 9.1% in 2016). One additional observation to mention is a small $150m increase of operating income as compared to a $4.9bn increase of revenues in the first half of 2017. The reason is an almost zero profitability of TNT Express, which is currently undergoing a restructuring process.
- For the company of its size, FedEx is historically generating a small amount of free cash flow. One of the reasons is large capital expenditures that exceed operating income most of the time.
- FedEx is steadily increasing dividend payouts to shareholders. Over the last 10 years, dividends have been growing with a CAGR of 19%. The latest annualised dividend amounts to $1.6, four times higher than in 2007. Still, the dividends are very low in comparison with the current share price. The dividend yield is 0.8%.
Trading Comparables Analysis
On Picture 3, you can see multiples comparison of FedEx with the industry average. Both EV/EBITDA and EV/EBIT multiples imply that FedEx is fairly valued.
Sources: FedEx Financial Reports, Morningstar, Damodaran
Taking into account the latest quarterly results, I expect the company's 2017 sales to be higher by c. $9bn than the year before. Most of the increase will be attributable to the consolidated financials of TNT Express. Having acquired its competitor, FedEx complemented its already existing air delivery service in Europe with ground delivery. I believe that the company's strengthened position in the Express segment, together with solid performance in the Ground segment, justifies my assumption of mid-single-digit growth rates of sales until 2020.
Also, I factor in a 10% operating margin since 2019 onwards in accordance with management's guidance in October investor presentation. Although current margin is lower, there are two reasons that might explain the expected increase. First, according to management, acquisition of TNT Express is estimated to bring $750m of synergies annually by the end of 2020. Second, profitability of TNT Express will increase (current operating margin is close to zero) since the company is undergoing a restructuring process.
The results of my DCF model are presented in Picture 4. The valuation date is the 1st of January 2017. For that reason I include a 5/12 stub of 2017 financials for the first projection year. All the assumptions that I made in my analysis are footnoted in the Excel file.
My model results in FedEx's Enterprise Value of $68.2bn. After accounting for net debt and after-tax pension provisions, I derive the equity value of $53.6bn that implies an intrinsic share price of $201. With FedEx's shares currently trading at $191.9, the stock is overvalued by 5%.
Sources: FedEx Annual Report 2016, Morningstar, Model created by author
You can see the sensitivity table on Picture 5. Applying different values of the company's WACC and terminal EV/EBITDA multiple, I derive that the intrinsic share price of FedEx lies in a range of $180-223.
Source: Model created by author
FedEx has offered attractive returns to investors since the start of the year. It was driven by positive expectations of the company's future performance after a string of acquisitions, including a takeover of TNT Express.
I recommend to HOLD shares of FedEx and expect their price to be in the range of $180-223 in the next 12 months.
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.