FedEx's Dividend Potential Is Just Beginning

| About: FedEx Corporation (FDX)
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Summary

FedEx may not meet your income requirements for any number of reasons.

Yet the company has a tremendous dividend growth asset in the way of a low payout ratio.

This article highlights the firm’s ability to be an ongoing dividend growth star.

Tennessee-based delivery company FedEx (NYSE:FDX) has been putting together a solid dividend growth record for the past decade and a half. Interestingly, this idea often flies under the radar of many income investors.

Personally I would chalk this up to three items: the length of history, a dividend "freeze" and the comparatively low starting yield. FedEx initiated a dividend back in 2002, which is a fairly long time, but this would still go unnoticed by those looking for 20 year+ streaks.

Second, FedEx elected to keep its $0.11 quarterly payment the same from July of 2008 through April of 2010 - representing eight straight quarters of a constant payout. This one is interesting too. On a yearly basis, you still see year-over-year increases. On a fiscal year basis (FedEx ends in May), it looks like the same payment for two years in a row - demonstrating a bit of the finicky nature in keeping track of dividend increase streaks; it can depend on your reference point.

By the way, FedEx did elect to keep the payout the same for eight quarters during the recession, but this payment was never really in jeopardy. FedEx earned around $5.80 per share in fiscal year 2008 before posting earnings near $3.80 in both 2009 and 2010. During that time the payout ratio "jumped" from 7% to 12% through the worst of it.

And third, as I write this the current dividend yield for the firm sits at "just" 0.96%. For any of these reasons, you may not think of FedEx as your quintessential income stock.

Yet here's the thing: just because FedEx is not a dividend stalwart today, this doesn't mean that it won't be in the years to come. And a chief factor will be the possibility for very robust dividend growth in the years to come.

When you're starting from nothing, it's easy to make the dividend growth rates look impressive. Yet I'd still contend that the recent history is noteworthy.

For instance, since 2015 FedEx has raised its dividend from $0.15 per quarter to $0.20, then $0.25, followed by $0.40 and the most recent announcement of $0.50 to be paid in July of this year. Those figures represent year-over-year growth rates of 33%, 25%, 60% and 25%. And that's after increasing the dividend by an average compound rate of north of 20% per annum in the prior 12 years.

The net impact that thus far? The company is still only expected to pay out 17% or so of anticipated adjusted profits for the year.

This outcome is a result of two factors: a low starting payout and solid earnings growth. Per share earnings growth has come in at about 6% per year for FedEx over the last decade. A lot of this was driven by "organic" increases in the business - net profit has climbed from $2 billion to $3 billion. And part of it was a result of share count reduction, which, incidentally, is fueled by a low dividend commitment.

And the dividend growth story is far from over. When you're paying out 17% of anticipated profits, that leaves a lot of wiggle room for future expansion. Add to this the propensity for earnings to keep growing at a solid clip, and you have a dividend growth star in the making.

Management at FedEx has laid out its goal of increasing earnings-per-share by 10% to 15% annually. Analysts come to a similar conclusion with 12% growth used as a midpoint for the intermediate-term.

For illustration, let's consider two scenarios. Instead of 12% or 15% growth, let's suppose FedEx can grow by 8% per year. At that rate, you would be anticipating $26 or so in earnings per share after a decade. If the dividend grew in line with earnings, naturally that would imply an 8% dividend growth rate as well. Yet that'd still leave the payout ratio where it was.

If FedEx instead elected to increase its payout ratio, the very robust growth of the past could continue into the future. A 40% payout ratio after 10 years, as an example, would imply an average compound dividend growth rate of nearly 18% per year. And even from there you still have the possibility for future growth / expansion.

Naturally if earnings grow faster (or if the payout ratio expands higher) the potential is even greater. Alternatively, suppose the business does not perform as anticipated. Instead of 8% yearly growth, you could use zero growth - that is, FedEx earning $12 or so in adjusted earnings this year and still earning that amount a decade from now.

It's worthwhile to note that due to ongoing share repurchases this scenario would actually imply negative company-wide growth. Using stagnant numbers, you can still see the benefit of starting with a low payout ratio. If FedEx elected to get its payout ratio up to 40% over the next 10 years with stagnant earnings growth, the dividend would still be growing by 9% per year.

As a point of reference, UPS (NYSE:UPS) currently pays out around half of its profits as cash dividends.

Obviously an investor's future success is going to depend on what happens with profitability: dividend growth is a byproduct of and not a driver of success. Yet the point is that FedEx presently has a resource in its low payout ratio.

It gives the company capacity to increase the dividend at a solid clip in a poor environment or at an exceptional rate when paired with earnings growth. Alternatively, it allows for great flexibility and added per share growth when diverted towards share repurchases. Or the most likely case - a combination of the two - can act nicely to supplement the increased shareholder return goal of the business.

In short, FedEx may not catch your attention on an income basis today as a result of its payout history length, the company's prudence during lesser times or the security's low starting yield. Yet all three of these items will eventually work themselves out as the company continues to expand its program. In the meantime, well above average dividend growth awaits those that are patient.

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.