Last weekend, China announced that it is targeting FedEx (FDX). It appears that China is happy to play the tit for tat game as the trade wars escalate. The US started things off by going after both a key Huawei executive and its ability to operate internationally. Now, China is starting to target American companies seemingly in response.
FedEx is one of the first to come under fire. Bloomberg said that China is building a blacklist of companies that it considers "unreliable" and FedEx is one of the first to be deemed as such. What was FedEx's reason for getting on to this list? China is reportedly investigating the company's "wrongful delivery of packages".
At first glance, that probably sounds incredibly petty. However, Reuters reported that some Huawei packages in particular that were supposed to be shipped from Japan to China were instead sent to the U.S. This implies that FedEx may have taken actions contrary to China's wishes rather than simply making honest mistakes.
In any case, FedEx has found itself as another target in the rapidly intensifying trade war. Before you panic and dump your FDX stock though, it's important to look at the bigger picture.
China: Not A Key Market
First things first, is China a major concern for FedEx? Judging by their latest 10-K, it doesn't appear to be overwhelmingly important, though the company certainly has a presence there. It built a new International Express and Cargo Hub in Shanghai which opened in January 2018. Additionally, it built its Asia-Pacific hub in 2009 in Guangzhou.
However, these facilities don't appear to be that central in the grand scheme of things. Its Guangzhou package sorting facility, for example, has sorting capacity of just 62,000 items per hour. That puts it below the capacity of its Paris international operation, in addition to domestic sorting facilities at Oakland, Newark, Fort Worth, Indianapolis, and Memphis. The Memphis operation alone has sorting capacity of 484,000 items per hour - nearly seven times the capacity of its Guangzhou site.
I'd further note that the latest FedEx 10-K only mentions the word "China" four times and makes no detailed discussion of the country in its risk factors. This implies that the overall impact from being labeled an unreliable partner by the Chinese government is quite modest.
Long-Term Market Dynamics Still Attractive
While FedEx stock has gotten annihilated over the past year, we have to ask how much of the current issues will really matter out beyond the next year or two.
The fundamentals for the business remain great. Globally, there are only three major players in the space: FedEx, UPS, and DHL. In the domestic U.S. market, you only have two, as DHL was forced to abandon America after suffering massive losses. In a market where you have just two or three competitors, it tends to keep pricing stable and profit margins high. With e-commerce sales only going upward, there should be plenty of demand to drive more business to both UPS and FedEx. Yes, I understand that bears suggest that the mechanics of the e-commerce business will drive down margins and that's perhaps true. But when you have a duopoly, it should insulate the companies from too much structural pricing decay.
And with the stock at just 10x earnings, even stable business results, let alone earnings growth, is plenty to make FDX stock a winner from this valuation.
But What About Amazon?
Of course, we must mention the elephant in the room. Like so many other battered stocks, FedEx has gotten hit in significant part by the Amazon (NASDAQ:AMZN) concerns. Amazon is building its own delivery capabilities to handle much of its own traffic and potentially even compete with FedEx and UPS.
There are also rumors swirling that Amazon may buy Boost Mobile as part of a forced divestiture from the proposed T-Mobile/Sprint merger. Amazon's real interest in the deal would likely be the wireless spectrum, not the company's current operations. And what would Amazon do with it? Potentially, they could use it for drone deliveries in the future, which could be a drag on FedEx's business. But is this realistic? Three decade veteran of the telecom business, Craig Moffett, told Bloomberg that it was not. He said:
Amazon may harbor long-term visions of wirelessly piloted delivery drones and driverless delivery vehicles, but the idea that one would want to operate their own proprietary network for such purposes is economically insane,"
He further added that:
Every once in a while, a news item comes along that is so bats**t crazy - sorry for the profanity, but your author is at a loss for a better word here - that one is simply brought up short,"
I'll side with Moffett, at least for now. This seems like another example where the Amazon rumor mill runs way ahead of what's actually happening. Amazon may eventually become a serious competitor to FedEx, but I wouldn't bet on it happening anytime soon. Low margin businesses where they have to compete with a highly skilled and entrenched monopoly don't really do much for Amazon's profits or the narrative that drives its stock price higher.
It's also worth noting SA author AllStarTrader's recent FedEx article. In it, AllStarTrader estimated that just 2-3% of FedEx's current business is delivering packages for Amazon. Furthermore, not even all of that business is at risk in the immediate term, as much of it is third-party fulfillment through Amazon that the e-commerce giant is unlikely to try to handle in-house anytime soon.
Dividend Is Safe
I'll briefly mention another recent article here on Seeking Alpha which suggested that FedEx's dividend could be at risk from rising trade war tensions.
The author makes a fair point in that the company has generated anemic free cash flow over the past couple of years. That's true. But it isn't the full picture. The company is still integrating its large TNT merger and has spent heavily on CapEx associated with that. Prior to 2017, the company was generating $3-4/share in FCF consistently, and free cash has rebounded in recent quarters after the heavy spending in 2018. The company's dividend is $2.60/share currently, so it could cover that out of its free cash flow from even pre-TNT days. And, presumably, the company should generate a lot more cash flow post-merger.
The balance sheet is BBB rated, which isn't great, but it's in investment-grade territory. In recent years, FedEx has spent much more on its share buyback than it has on its dividend. If anything, I'd expect it to cut the buyback long before the dividend. Finally, with earnings of more than $15 per share, on a payout ratio basis, the dividend is a modest ~17% of earnings.
FDX Stock Takeaway
This drop in FedEx stock is getting ridiculous. Shares are already back to where they were at the worst of the December correction. FDX stock has bounced a little this week but is still just four percent off its 52-week lows.
Yet, the company is still set to earn more than $15/share this year, despite the global slowdown. Sure, earnings will be down by something like $1/share this year due to the global slowdown and trade war concerns. But the stock is down from $230 to $155 since November. Was that $1/share of earnings power really worth $75 per share in FedEx's stock price?
FedEx stock got clocked during the Great Financial Crisis as well. But it bounced back in a hurry as people realized that a brief drop in earnings hadn't done anything to disrupt the business's long-term tremendous power and entrenched competitive position:
Regardless of how deeply FDX stock slumps during this downturn, I expect shares to turn sharply higher, surpassing $200 again as soon as sentiment picks up about global economic conditions.
This is an excerpt of this past Sunday's Weekend Digest. Subscribe now to get the full edition of this and all future digests. Ian's Insider Corner membership also includes an active chat room, initiation reports for new stock purchases, and my responses to your questions.
Disclosure: I am/we are long FDX. 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.