Growth Stocks: FedEx

Prior to FedEx's earnings report

The market anticipates that FedEx Corporation (FDX.US) will announce its financial results for the first quarter (FQ1-24) with the following figures:

• Estimated revenue of approximately $21.8 billion.
• Estimated earnings per share (EPS) of around $3.73.

During this quarter, there is also an expected decrease in revenue for both the Express and Ground segments, while growth is anticipated in the Freight segment due to higher revenue per hundredweight.

• The company's operating ratio is projected to increase to 98.1%, up from 93.2% in the previous quarter (FQ4).

Several significant events likely contributed to FedEx's performance during this quarter, including Yellow's exit from the Less-Than-Truckload (LTL) market, revenue benefits from the UPS-Teamsters labor dispute, and the positive impact of rising fuel prices. Some analysis banks, such as Bank of America, consider discussions on costs and prices during FedEx's upcoming earnings conference on September 20th at the close of the Wall Street session to be crucial in determining the direction of FedEx's stock.

It is important to note that FedEx recently announced plans to increase shipping rates and customs brokerage service fees for imports starting on January 1, 2024. This will affect FedEx Express, Ground, Home Delivery, and Freight services, with an average increase ranging from 5.9% to 6.9% for shipments within the United States.

Context Leading Up to the Results

FedEx is currently a value company, given its solid foundations and proactive approach to financial challenges. The company demonstrates competitiveness and has effectively addressed financial obstacles. However, its current market valuation does not offer substantial security in light of potential economic recession risks. While FedEx has the potential for annual growth of around 8% (CAGR) in the next five years, there may be more attractive investment opportunities with a better balance between risk and reward available. Until there is greater clarity on the economic outlook or stocks become more reasonably priced, I believe FedEx shares should be held in a portfolio.

Company Positioning

FedEx stands out as a global leader in logistics, offering a diverse range of services through its subsidiaries. The FedEx Express division focuses on rapid international shipments, while FedEx Ground specializes in small package delivery in North America. Additionally, FedEx Freight handles retail shipments, and FedEx Office provides various business services.

Fundamentally, FedEx's business model emphasizes speed and reliability. It relies on a hub-and-spoke system, centralizing packages at key centers before sending them out. This approach ensures efficiency and allows FedEx to provide timely services to over 220 countries. Furthermore, the use of technology for tracking and optimization enhances the overall customer experience.

However, FedEx faces strong competition, primarily from UPS (UPS.US), and the entry of Amazon (AMZN.US) into logistics. Despite increasing competition, I believe FedEx maintains a strong position as a key player in the logistics industry.

Market Dominance and Strategic Advantages of FedEx

The logistics and delivery industry is predominantly controlled by FedEx and UPS, with FedEx holding a substantial market share of 47.78% as of the second quarter of 2023. This duopoly underscores the scale and efficiency of these industry giants. FedEx's extensive global network spanning over 220 countries provides it with a unique competitive advantage. Notably, the company's economies of scale allow it to distribute fixed costs among a large number of shipments, reducing the average cost per package and strengthening profitability.

Furthermore, FedEx's operational scale serves as a substantial barrier to entry for potential competitors. The capital required to achieve a similar level of efficiency is prohibitively high, making it difficult for newcomers to pose a credible threat. The company's versatile fleet and global reach are key assets, enabling it to optimize cost structures and minimize the impact of price competition. The presence of Amazon Logistics has not significantly disrupted the market dynamics, which continue to favor FedEx. The company's economies of scale reinforce its competitive position, allowing it to meet various customer demands while maintaining cost advantages. This highlights FedEx's resilience and competitive power within a challenging industry landscape.

Source: CSI Market

Competitive Advantage of FedEx's Brand Strength

FedEx's brand strength stands out as a substantial asset in the fiercely competitive logistics industry. The company's reputation for reliability and customer service has been instrumental in retaining a loyal customer base and attracting new customers.

A survey conducted by Sage Frog Marketing Group provides compelling evidence of this phenomenon, with FedEx ranking as the second most trusted business-to-business (B2B) brand in America. It trailed only behind Amazon (AMZN.US) in this ranking, surpassing other major brands such as Google (GOOG.US) and Johnson & Johnson (JNJ.US). 

This high level of trust fosters deep customer loyalty, encouraging both individuals and businesses to rely on FedEx for their long-term shipping needs. This not only contributes to FedEx's steady revenue stream but also creates a formidable barrier to entry for potential new competitors. In summary, FedEx's strong brand presence and unwavering commitment to customer satisfaction provide it with an exceptionally robust competitive advantage.

Source: Sage Frog Marketing Group 

Navigating Financial Headwinds

Assessment of FedEx's Financial Outlook

I believe FedEx's financial prospects for the next year present significant challenges, especially in light of recent adverse trends observed in its key financial indicators.

In the fourth quarter of 2023, the company experienced a 10% year-on-year decline in its revenues, a notable 28% year-on-year reduction in adjusted earnings per share (EPS), and a significant 21% contraction in adjusted operating income. The major factors driving this slowdown can be attributed to the overall economic slowdown, exacerbated by rising interest rates and inflationary pressures. These factors have resulted in a decline in shipping volumes for the company.

Source: quarterly report FedEx Q4 2023.

Challenges on the Horizon for FedEx

FedEx faces imminent financial hurdles, with two prominent issues in the forefront:

• Rising fuel prices.
• A shortage of delivery drivers, both putting pressure on the company's operating margins.

Additionally, FedEx is grappling with declining shipping volumes in several categories, including an 8% year-on-year decrease in domestic package shipments, a 3% year-on-year decline in international exports, a contraction of -2% year-on-year in the Ground segment, and a significant 17% year-on-year drop in the Freight segment. 

While there have been indications of a gradual recovery in the FedEx Express and FedEx Ground segments in the last six months, FedEx Freight has not shown strong signs of recovery yet. Consequently, this presents a challenging outlook for profit prospects in the next year. In the event of an economic recession in the next twelve months, it is possible that all FedEx segments will experience reduced volumes and maintain negative year-on-year growth.

Source: quarterly report FedEx Q4 2023.

Strategic Cost Efficiency Initiatives

Assessing FedEx's recent results, FedEx is actively taking strategic measures to address its financial obstacles through the implementation of its Cost Reduction Plan. This comprehensive plan encompasses several key elements designed to improve the company's financial well-being. A notable initiative involves aligning flight hours more efficiently with demand, resulting in a significant 12% reduction in global flight hours during the fourth quarter of fiscal year 2023. This is part of a broader cost-cutting effort that yielded a substantial $2 billion reduction in year-on-year operating costs during the same quarter. Specific actions taken include the permanent retirement of 18 aircraft, including 12 MD-11s, in the fourth quarter of fiscal year 2023.

McDonnell Douglas MD-11 model, used by FedEx.

Additionally, the company has been proactive in managing its workforce, including hours worked. Furthermore, FedEx has reaped the benefits of its DRIVE transformation program, aimed at improving operational efficiency. These strategic maneuvers indicate that FedEx is proactively addressing its financial challenges, emphasizing cost reduction while still fulfilling its commitments to customers and employees. Therefore, as economic challenges subside, there is a strong likelihood that operating margins will surpass previous levels, potentially leading to a significant increase in profits attributable to these cost-saving initiatives.

Source: quarterly report FedEx Q4 2023.

Financial Evaluation

Over the past five years, FedEx has demonstrated strong financial performance. Its revenues have shown steady and substantial growth, increasing from $65.45 billion in 2018 to $90.155 billion in 2023. This represents a compound annual growth rate (CAGR) of approximately 6.6%. However, earnings per share (EPS) have remained relatively stable, experiencing a slight decline from $16.79 in 2018 to $15.48 in 2023. This decline reflects the company's recent struggle to curb the erosion of operating margins due to rising operating expenses. It is expected that operating margins will eventually recover, driven by the ongoing implementation of the Cost Reduction Plan and the eventual resolution of concerns related to an impending recession.

Source: DJTF Investments 

In the most recent quarter, FedEx reported total cash and cash equivalents of $6.856 billion. The company's total debt stands at $19.728 billion, a manageable amount that could potentially be fully covered by approximately four years of projected free cash flow for 2023. The current ratio, which assesses the company's ability to meet short-term obligations with short-term assets, is at a healthy 1.37, surpassing the critical threshold of 1.

As mentioned earlier, we anticipate that upcoming quarterly earnings reports may pose challenges due to a decrease in total package volume attributed to adverse macroeconomic conditions affecting economic activity, as well as rising labor and fuel costs.

Looking beyond the next 12 months, and assuming a return to favorable macroeconomic conditions, I believe the company is well-positioned to improve its margins due to the ongoing implementation of the Cost Reduction Plan.

Valuation Assessment

When conducting a valuation, we must consider the implications of evaluating what we are paying for the business (market capitalization, the stock) compared to what we are receiving in terms of underlying business fundamentals and future earnings. A common method to measure this relationship is through a discounted cash flow (DCF) analysis of the business.

As of the fourth quarter of 2023, FedEx's trailing twelve-month (TTM) cash flow per share is $10.45. Assuming a return to a favorable macroeconomic environment, with normalized cash flows and margin expansion as a result of the Cost Reduction Plan, we anticipate a conservative annual growth rate of 13% over the next five years. Therefore, taking into account this growth rate, for the fourth quarter of 2028, FedEx's cash flow per share is projected to reach $19.25. Applying a exit multiple of x16, this implies a price target in five years of $373.35 (+49.81% over yesterday's closing price).

FedEx’s Chart

Consequently, based on these estimates, if someone were to purchase FedEx at the current price of $250, it could result in a Compound Annual Growth Rate (CAGR) of 8% over the next five years. Source: xStation

Conclusion

In summary, if an investor finds an annual return of 8% acceptable, FedEx's shares could be on their wishlist. However, in the current context, there are more attractive opportunities in the market that offer potentially higher returns but also come with higher risks.

Although FedEx has a solid business model and holds a dominant position in the market, the risks of an impending recession and its current valuation do not provide a suitable margin of safety for all investment profiles.

FedEx's extensive global operations and economies of scale give it a substantial competitive advantage in the logistics industry. Its position as the second most trusted B2B brand in America underscores its customer loyalty and market position. Despite facing economic challenges, the proactive implementation of the Cost Reduction Plan positions the company well for future growth. Financial projections indicate a possible Compound Annual Growth Rate (CAGR) of 8% over the next five years. While FedEx remains a market leader with a solid business model, there may be superior investment prospects available in the market for those seeking higher returns.

Darío García, EFA

XTB Spain