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Even After A 40% Decline, FedEx's Weak Free Cash Flow Limits Shareholder Value Creation

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About: FedEx Corporation (FDX)
by: Chad Brand
Summary

Whenever leading brands like FedEx see their stocks drop by 40% from 52-week highs, value investors should take a closer look.

Despite the lower valuation, underlying cash flow generation at FedEx has been weak for the last decade.

As long as the company needs debt financing to fully fund share buybacks, dividends, and ongoing capital needs, investors should be wary.

Back in 2006, shares of package delivery giant FedEx (FDX) peaked at around $120 before the recession hit. Thirteen years later FDX stock is trading down 40% from its 52-week high and even more from its latest peak (late 2017). Given the surge in e-commerce and the associated demand for global shipping services, the fact that FDX fetches just $140 per share in 2019 might look attractive to value-seeking investors:

Chart Data by YCharts

So how is it exactly that FDX is only in the low $140s versus $120 in 2006, given that the company's annual revenue has surged from $50 billion to $70 billion during that time? Sub-par cash flow generation on that revenue, to put it simply, would be my answer.

I went back and looked at FDX's free cash flow in dollar and margin percentage terms over the last six years compared with total revenue:

  • 2014: Revenue: $45.5B | FCF: $0.7B | 1.6%
  • 2015: Revenue: $47.4B | FCF: $1.0B | 2.1%
  • 2016: Revenue: $50.3B | FCF: $0.9B | 1.8%
  • 2017: Revenue: $60.3B | FCF: ($0.2B) | (0.3%)
  • 2018: Revenue: $65.4B | FCF: ($1.0B) | (1.5%)
  • 2019: Revenue: $69.6B | FCF: $0.1B | 0.2%
  • Total: Revenue: $338.8B | FCF: $1.6B | 0.5%

Source: Annual 10-K filings for last six fiscal years ending in May

To put that $1.6 billion of cumulative free cash flow over the past six fiscal years into perspective, FDX's current market value is around $37 billion, so the stock is trading for 23 times trailing 72-month free cash flow. That is not exactly cheap despite the precipitous fall from the all-time high on a per-share quote basis.

Perhaps it is unsurprising that a large, global logistics business like this is highly capital intensive and generates relatively low free cash flow. However, investors should be worried more when they see how much capital FDX has been returning to shareholders during this time.

Again, from the company's filings, take a look at dividend payments and stock buybacks over the last six years:

  • 2014-2019 Cumulative Dividends Paid: $2.3 billion
  • 2014-2019 Cumulative Stock Buybacks: $11.8 billion

Taken together total capital return has amounted to $14.1 billion or $2.35 billion annually since 2014, which is 781% more than cumulative free cash flow generated from the business.

So how has FDX been able to manage such a disparity between cash profits available for distribution and actual dividend and buyback activity? As you might have guessed, the answer is it has borrowed the money and turned right around and paid it out to its investors:

  • 2014 Year-End Long-Term Debt Balance: $4.7 billion
  • 2019 Year-End Long-Term Debt Balance: $16.6 billion
  • 6-Year Increase in Long Term Debt: $11.9 billion

Coincidentally, total long-term debt increases of $11.9 billion nearly map right onto the difference between total capital returns ($14.1 billion) and operating free cash flow ($1.6 billion) since 2014. So what conclusions can we draw about FDX's financial results and capital allocation strategy and their likely impact on future stock price performance?

Well, first of all we can see why FDX stock has made minimal progress in recent years. Free cash flow has been stagnant even as revenue increases have been significant. The company has tried to offset this unimpressive financial performance by continually increasing its dividend and buying back stock to boost per-share figures, but its balance sheet is further impaired as a result.

Looking ahead, there is little reason for optimism. Free cash flow remains weak and the company is likely to continue investing heavily in its business now that Amazon (NASDAQ:AMZN) is making a big push into logistics and delivery.

Further debt increases have an upper bound limit since borrowings have been growing faster than profits. Credit ratings matter and FDX is not going to endanger its investment-grade rating. As a result, stock buybacks will likely trail off relative to the recent past.

As for the dividend, it would be nice to conclude that FDX has room to keep increasing that, at the very least, but even that is unclear. For the past three years, free cash flow has failed to cover the dividend. Unless the profitability of this business picks some steam soon, large dividend increases are unlikely. Management will still likely opt for small increases, but such a call will not be backed by cash flow, but rather the pressure to appease frustrated investors.

In conclusion, I was hoping that FDX would look attractive after a huge decline. That is why I took a deeper look to start with. What I found was a company that despite a strong brand and surging revenue from steadily rising package delivery demand still generates minimal free cash flow. Ill-advised stock buybacks have increased leverage, which will only serve to limit future levers the company has available to increase shareholder returns. Despite what seems like a cheap price, relative to the past 12 months, I see no reason to be bullish about FedEx's future stock price potential.

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.