FedEx Inc. Stock Report

FedEx Inc.

The graph of the annual revenue per share (red line) for FedEx shows steady growth with a recent acceleration.

Adjusted earnings per share have grown at a very strong rate since 2009 with a slowdown in 2013. Recent adjusted earnings per share growth has been very strong.

The adjusted earnings line is quite far below the revenue line which is due to this being a low net profit margin business. The low net profit on sales (currently 6.2%) is part of the reason that earnings can drop very quickly as revenues drop. But it also means that profits can rise very quickly when things improve (as has been the case lately).

The book value per share (green line) did not grow much through 2016, partly due to share buy backs, but has recently grown with higher earnings and a lack of share buy backs.

FedEx (FDX,NY)
RESEARCH SUMMARY  
Report Author(s): InvestorsFriend Inc. Analyst(s)
Author(s)’ disclosure of share ownership:  Author(s) hold no shares
Based on financials from: May ’17 Y.E. + Q3 ’18
Last updated: 30-Apr-18
Share Price At Date of Last Update:  $                            247.12
Currency: $ U.S.
Generic Rating (This rating does not consider the circumstances of any individual investor and is therefore not specific advice for any individual): Buy rated at $247
SUMMARY AND RATING: This cell of the report summarizes information from the other cells. FedEx historically qualifies as a moderately “great company” with historic good growth in revenue and earnings per share – but it did falter significantly during the 2008 recession (see graph) . The economics of the business currently are very good given the increase in margins in the past two years including customer acceptance of price increases and especially given the benefits of the lower income tax rate in the latest quarter.  The outlook for revenue growth does seem reasonably predictable although relatively modest. Value ratios indicate a (lower) Buy unless one assumes double digit growth. The outlook is for continued growth with a substantial boost due toe lower income tax rate in the next three quarters.  FedEx has the competitive advantage of scale and top-of-mind brand name. It has been able to implement annual price increases which indicates a strong market position.  The insider sales signal is  negative. The recent earnings trend has been quite strong. Management is good and trustworthy.  The company does well on most of the key Buffett criteria but does require continuous capital spending.  Overall, we rate FedEx a Buy at this time.
LONG TERM VALUE CREATION. FedEx has exhibited excellent long-term value creation given current investor capital of $3.1 billion and accumulated earnings (after deducting a modest amount of dividends) of $23.7 billion. On top of that its net $18.9 billion in book equity (which deducts $7.6 billion paid out to repurchase shares) is valued in the market at $67 billion. In effect something like $3.1 billion in capital raised from investors has been turned into $67 billion of value. As further evidence of the value creation, FedEx went public in 1978 at $0.75 per share (adjusted for splits). We are not aware if it subsequently issued additional shares at higher prices other than through the exercise of options. Of course, most of the huge value creation occured in the early years.
DESCRIPTION: (Updated October 2017). A huge transportation company with $60 billion in annual revenue and $49 billion in assets it operates in virtually every country in the world. It transports mostly small parcels and envelopes by air and ground mostly on a next-day-delivery basis but also offers less urgent delivery and delivers larger packages and freight as well. It has several main operating subsidiaries.   FedEx Express (which includes the TNT acquisition) provides global (mostly air) transportation and information networks to deliver priority parcel, envelop and freight delivery to more than 220 countries and territories   (57% of revenues, 48% of operating income). FedEx Ground provides express parcel and envelope delivery throughout the USA and Canada (30% of revenues, 42% of operating income).  FedEx Freight is a North American less-than-truck-load freight company (11% of revenues, 7% of operating income).  FedEx Services includes retail Office and centralized functions including customer services the retail offices are a leading provider of document solutions (and a FedEx drop off point) with a global network of about 1,800 locations (3% of revenues, all income or loss is allocated to the other divisions). The company is labour intensive with about 400,000 employees and contractors. Employee costs account for 36% of its revenues. Another 23% is purchased transportation which is largely its independent contractors, owner operators of delivery trucks. This employee intensiveness means that costs are to a good degree variable with volume and this helps FedEx manage costs during recessions. This is a company where the pension tail could wag the company dog. Pension Assets are $26.3 billion, obligations are $30.8 billion for a shortfall of $4.5 billion which compares to common equity of $16.6 billion. Pension issues have reduced book value by a noticeable amount in recent years and also reduced net income. However, in general the pension plan is still in relatively good shape. Higher interest rates could substantially improve the pension situation going forward.
ECONOMICS OF THE BUSINESS: (Updated for Q3, fiscal 2018) The ROE based on adjusted earnings is very good at  21.0% of ending equity. Adjusted profits on sales were 6.2% in the trailing year. This was slightly leveraged up to 7.64% profit on assets because sales are larger than assets. This was further leveraged up to the 21.0% on ending equity as ending assets were 2.74 times larger than the common equity. Overall this demonstrates very good economics.
RISKS: The annual report provides a comprehensive list and discussion.  Litigation concerning its position that its ground drivers are contractors and not employees is a risk. Possibly advances in electronic document transmission and signatures could reduce the number of documents being shipped. Pension obligations are a risk as interest rates remain at almost record lows. A recent cyber attack illustrates the risk in that area.
INSIDER TRADING / INSIDER HOLDING: From Yahoo Finance – share transactions in the public market.  In the past nine months 11 insiders sold shares (often about $1 million worth and in three cases it was 3, 6 and 12 million dollars worth) at prices from $208 to $266 mostly after exercising options. Only one buy is shown, a director (who may have been required to buy) bought $20,000 worth at $248. Overall, this insider trading signal is negative. The company reduced repurchased its own shares in 2017 and prior but ceased doing so as the price rose above $190.
WARREN BUFFETT’s CRITERIA: Buffett indicates that all investments must pass four key tests: the business is simple to understand (pass, basically picking up small parcels and delivering them), has favorable long-term economics due to cost advantages or superior brand power (pass given dominant position), apparently able and trustworthy management (pass with respected founding CEO), a sensible price – below its intrinsic value (marginal pass), Other criteria that have been attributed to Buffett include: a low debt ratio (pass), good recent profit history (pass) little chance of permanent loss of capital (pass) a low level of maintenance type capital spending required to maintain existing operations excluding growth (apparent fail – aircraft and trucks may require constant spending).
MOST RECENT EARNINGS AND SALES TREND: Adjusted earnings per share growth in the past four quarters, starting with the most recent quarter which was Q3, 2018, ended February 28, 2018) rose (a stunning) 59%, rose 20%, rose 17%, and rose 28%. Revenues per share growth in the past four quarters, starting with the most recent was 9%, 9%,3%, and 20%.  In fiscal 2017 (ended May 31, 2017) adjusted earnings per share growth was 21% and revenue per share growth was 24%. In fiscal 2016 (ended May 31) adjusted earnings per share growth was 14% and revenue per share growth was 9%.  In fiscal 2015 (ended May 31) adjusted earnings per share growth was 32% and revenue per share growth was 12%. In fiscal 2014 (ended May 31) adjusted earnings per share growth was 8% and revenue per share growth was 5%.  Overall the recent earnings trend has been very strong. In the four fiscal years ended with 2017 (but not in the latest four quarters) results have been boosted by substantial share buy-backs. The sharply higher earnings per share in the latest quarter was apparently entirely due to the lower income tax rate.
COMPARABLE VOLUME SALES: FedEx Express (mostly Air) Daily package volume growth in the past four quarters beginning with the most recent which was Q3 2018, was down 1%, up 3%, up 2%, in Q1 and meaningless at about 46% in Q4 due to a huge acquisition. FedEx Ground daily package volume growth was up 6%, up 7%, 4.0%, and 3.3%. Freight shipments in the same quarters were up 6%, up 4%, up 1.2%, and down 0.1%. Overall, the recent volume of packages is growth is relatively strong although the air volume was down 1% in the latest quarter..
Earnings Growth Scenario and Justifiable P/E:  If earnings were to grow at 7% per year for ten year and the dividend payout ratio remain at about 10% followed by growth at the nominal rate of growth in the economy of about 5% and a dividend payout ratio of 50% we can justify a P/E of 16. (And the company is trading at trailing P/E of 17).
VALUE RATIOS: (Based on a $223 share price). Price to book value is perhaps unattractively high at 3.6 although it mathematically reflects the high adjusted earnings ROE of 23.3% multiplied by the neutral P/E of 17.0. The trailing adjusted earnings P/E is neutral in attractiveness at 17.0. Based on management’s projected earnings for the year ended May 2018 the P/E is about neutral in attractiveness at 16.3. The dividend yield is minimal at 0.8%, despite healthy annual dividend increases, as only 14% of adjusted earnings are paid out as a dividend. Adjusted earnings per share for the past five fiscal years increased by  a 13% per year compounded average.  Sales per share were up a compounded  average of 10.7% per year in the past five years.  We calculate an intrinsic value at $194 assuming a more conservative 5% annual growth with a lower terminal P/E ratio of 14 in five years and $266 assuming a more optimistic 9% growth in earnings and a terminal P/E ratio of 16 based on a five year holding period and using a required return of 7.0%. Overall the value ratios would indicate a  very strong company that is about fairly valued indicating a (lower)Buy rating unless one is prepared to forecast growth higher than about 9%.
SUPPORTING RESEARCH AND ANALYSIS  
Symbol and Exchange: FDX, New York
Currency: $ U.S.
Contact: investor.relations@fedex.com
Web-site: www.fedex.com
INCOME AND PRICE / EARNINGS RATIO ANALYSIS  
Latest four quarters annual sales $ millions: $63,864.0
Latest four quarters annual earnings $ millions: $4,465.0
P/E ratio based on latest four quarters earnings: 15.1
Latest four quarters annual earnings, adjusted, $ millions: $3,961.1
BASIS OR SOURCE OF ADJUSTED EARNINGS:   Added back various write-offs and one-time items identified by management. We deducted two additional gains in Q2 2017 that management identified but failed to deduct in their version of adjusted earnings also costs related to a cyber attack and hurricanes identified but not adjusted by management in Q1 2018.
Quality of Earnings Measurement and Persistence: Reasonably Reliable, most expenses are cash expenses and the depreciation expense although estimated is only about 5% of revenue and not that large in relation to wage expenses. Also with assets 53% depreciated the provision appears to be ample.  The business operates on a cash or very short receivables basis so the measurement of revenues and current assets are likely quite accurate.  Earning growth persistence had been strong historically but earnings were hit hard with the 2008 recession and took several years to recover. The pension and post-retirement health care costs are large and difficult to estimate and negatively impact earnings reliability.
P/E ratio based on latest four quarters earnings, adjusted 17.0
Latest fiscal year annual earnings: $2,997.0
P/E ratio based on latest fiscal year earnings: 22.4
Fiscal earnings adjusted: $3,331.8
P/E ratio for fiscal earnings adjusted: 20.2
Latest four quarters profit as percent of sales 6.2%
Dividend Yield: 0.8%
Price / Sales Ratio 1.05
BALANCE SHEET ITEMS  
Price to (diluted) book value ratio:                                         3.57
Balance Sheet: (Updated Q1, fiscal 2018 ended August 31) 53% of the assets are in property and equipment. (The property and equipment is 53% depreciated which might suggest that the depreciation expense has been ample) 19% of assets are in (largely) receivables plus prepaids and inventory, Purchased goodwill represents 15% of assets. Cash represents 7% of assets.  The remaining 6% is in other assets. These assets are financed 34% by equity (the vast majority of which is retained earnings rather than original invested capital which testifies to the historic profitability of the company),  31% by debt, 16% by current payables, 9% by pension obligations, 6% by deferred income tax and 4% by other items including self-insurance and a deferred lease obligation.  This is a relatively strong balance sheet.
Quality of Net Assets and Book Value Measurement: With a recent price to book ratio at 3.6, it’s worth considering the true value of the assets. The assets are high quality, mostly consisting of planes, vehicles, package handling equipment and buildings. Goodwill is relatively modest.  The goodwill represents approximately 15% of total assets or 44% of equity.  It is impossible to say to what extent the market value of the assets exceeds the book value but clearly, they do. The company is valued for its earnings not its assets.
Number of Diluted common shares in millions:                                 273.0
Controlling Shareholder: (Updated from 2017 circular)  F.W. Smith Chairman and  (founding) CEO owns 7.8% of the shares but does not technically control the company. There is substantial institutional ownership and three funds are shown as owning about 6% each. Collectively the institutional investors could likely control the Board selection if they wished to but meanwhile effective control likely lies with the founder and CEO.
Market Equity Capitalization (Value) $ millions: $67,463.8
Percentage of assets supported by common equity: (remainder is debt or other liabilities) 36.4%
Interest-bearing debt as a percentage of common equity 93%
Current assets / current liabilities: 1.4
Liquidity and capital structure: Highly liquid with a manageable debt level (91% debt to equity ratio). S&P apparently rates it only a BBB.
RETURN ON EQUITY AND ON MARKET VALUE  
Latest four quarters adjusted (if applicable) net income return on average equity: 23.2%
Latest fiscal year adjusted (if applicable) net income return on average equity: 22.3%
Adjusted (if applicable) latest four quarters return on market capitalization: 5.9%
GROWTH RATIOS, OUTLOOK and CALCULATED INTRINSIC VALUE PER SHARE  
5 years compounded growth in sales/share 10.7%
Volatility of sales growth per share:  Steady but growth falters during recessions
5 Years compounded growth in earnings/share 11.6%
5 years compounded growth in adjusted earnings per share 13.4%
Volatility of earnings growth:  Volatile in recessions
Projected current year earnings $millions: $4,149.6
Management projected price to earnings ratio: 16.3
Over the last ten years, has this been a truly excellent company exhibiting strong and steady growth in revenues per share and in earnings per share? Yes, long term
Expected growth in EPS based on adjusted fiscal Return on equity times percent of earnings retained: 19.2%
More conservative estimate of compounded growth in earnings per share over the forecast period: 5.0%
More optimistic estimate of compounded growth in earnings per share over the forecast period: 9.0%
OUTLOOK FOR BUSINESS: Earnings growth could be very strong in the next three quarters due the lower income tax rates assuming that the lower tax does not lead to increased price competition. It seems relatively certain that FedEx will continue to grow over the years. We would expect more modest growth after calendar 2018 (when it lapped the quarters with the lower tax rate), perhaps in the 7% range. Earnings growth will be higher through 2020 as the company is projecting substantial synergy savings as it integrates the TNT acquisition.
LONG TERM PREDICTABILITY: FedEx appears to be reasonably predictable in terms of future growth.
Estimated present value per share: We calculate $195 if adjusted earnings per share grow for 5 years at the more conservative rate of 5% and the shares can then be sold at a P/E of 14 and $266 if adjusted earnings per share grow at the more optimistic rate of 9% for 5 years and the shares can then be sold at a P/E of 16.  Both estimates use a 7.0% required rate of return.
ADDITIONAL COMMENTS  
INDUSTRY ATTRACTIVENESS: (These comments reflect the industry rather than any particular company.) Michael Porter of Harvard argues that an attractive industry is one where firms are somewhat protected from competition (pass on a world-wide scale, great amount of competition at the local and regional level).  Barriers to entry (Pass with some barriers such as scale).  No issues with powerful suppliers (pass). No issues with dependence on powerful customers (pass, well diversified customer base), No potential for substitute products (marginal pass as although customers are seeking lower cost alternatives but they are slower and the internet may be an alternative to shipping documents). Overall this industry appears to be attractive for FedEx as a large incumbent .
COMPETITIVE ADVANTAGE: Its scale and global coverage offer a competitive advantage. Its top-of-mind brand awareness and the fact that customers would face some inconvenience in switching (learn new package booking procedures) gives it barriers to entry.  Its competitive advantage seems strongest in air and priority ground but may not apply to its less than truckload operations.
COMPETITIVE POSITION: We have not seen comprehensive figures regarding its market share. It has a 30% share of the U.S. ground parcel market. It indicates that its market share has been increasing.
RECENT EVENTS: The Trump tax cuts led to a substantial one-time gain in Q3 fiscal 2018 as the deferred income tax “liability” was sharply reduced. The tax cuts also resulted in a substantial earnings growth in Q3 fiscal 2018 and this should be the case in the next three quarters as well unless competitors lower rates to reflect the lower tax cost. However, the income tax on adjusted earnings in the latest quarters appears to be close to zero and this cannot be the case going forward.  FedEx announced it will partner with Walgreens to add 8000 pick up / drop off locations. A cyber attack at its newer TNT division in June 2017 caused business disruption and incurred substantial costs. Fed Ex is investing to renew its aircraft fleet and is also investing in its ground assets. In 2016 completed a large acquisition for $4.8 billion (for comparison FedEx’s assets were $37 billion) of TNT Express. TNT provides express delivery in most of the world outside of North America mostly on a business to business basis and mostly ground transportation.  This has increased the debt leverage on the balance sheet but the debt is still not excessive. The dividend has increased substantially but the yield remains low at 0.8% as it retains most of its earnings. FedEx raised rates in all of its divisions by 4.9% at the start of calendar 2016, and made similar increases at the start of 2017 and at the start of 2018.
ACCOUNTING AND DISCLOSURE ISSUES: The company reports changes in volume shipped (not just dollars) which is helpful. The summary earnings release is brief but to the point. There was a particularly good discussion of pension accounting issues. The annual report provides excellent and yet concise detail by segment. But, some write-offs in the past were described as “non-cash” which seems a bit dismissive of losses. A recent change to marking the net pension liability to market has added volatility to GAAP earnings. In Q2 2017 they failed to deduct some unusual gains in adjusted earnings. In Q1 2018 quarter they could have added back costs associated with a cyber attack but did not, so they are being conservative there. They indicate that starting fiscal 2018 they will no longer adjust for amortization of purchased intangibles. We think that should be adjusted for (which would add to adjusted earnings). Amortization of intangibles is not separated out from depreciation in the earnings news release.
COMMON SHARE STRUCTURE USED: one vote one share
MANAGEMENT QUALITY: Management quality seems good. Management appears to have made good cost cutting measures in recent years. Still led by its founder. The nature of the information in the annual report suggests a shareholder oriented management that understands what drives profitability. However there were some past mistakes. It probably over-paid for certain acquisitions including Kinkos. It apparently made smart choices in repurchasing shares in 2014 through 2017 at good prices. They missed an opportunity to buy back more shares at better prices in 2012
Capital Allocation Skills: Management appears to have made reasonably good choices in investing its capital and in its financing. It has spent heavily on share repurchases at prices that were attractive although it could have  done so earlier at more attractive prices. The dividend payout ratio is only about 1r%. With an ROE that is typically in double digits, and recently over 20%, on an equity base that has increased substantially in the past ten years there is no indication that capital spending and acquisitions have been unwise. However there have been large write-offs of goodwill in regard to its acquisition of the former Kinkos retail services outlets indicating that this particular acquisition may not have been wise.
EXECUTIVE COMPENSATION: Updated for 2017 fiscal figures.  Generous ranging from $5 to $16 million for the named executives for fiscal 2017.  Overall the compensation seems somewhat generous but it is not a concern given the size of the company.
BOARD OF DIRECTORS: (From 2017 proxy circular document) The Board appears to be suitably qualified. Director compensation is about $350,000 per year, which could limit independence. Overall it is probably a good Board
Basis and Limitations of Analysis: The following applies to all the companies rated. Conclusions are based largely on achieved earnings, balance sheet strength, achieved earnings per share growth trend and industry attractiveness. We undertake a relatively detailed  analysis of the published financial statements including growth per share trends and our general view of the industry attractiveness and the company’s growth prospects. Despite this diligence our analysis is subject to limitations including the following examples. We have not met with management or discussed the long term earnings growth prospects with management. We have not reviewed all press releases. We typically have no special expertise or knowledge of the industry.
DISCLAIMER: All stock ratings presented are “generic” in nature and do not take into account the unique circumstances and risk tolerance and risk capacity of any individual. The information presented is not a recommendation for any individual to buy or sell any security. The authors are not registered investment advisors and the information presented is not to be considered investment advice to any individual. The reader should consult a registered investment advisor or registered dealer prior to making any investment decision. For ease of writing style the newsletter and articles are often written in the first person. But, legally speaking, all information and opinions are provided by InvestorsFriend Inc. and not by the authors as individuals. The author(s) of this report may have a position, as disclosed in each report. The authors’ positions may subsequently change without notice.
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