FedEx Earnings Preview: Undervalued With DE Shaw Involved


FedEx Freight truck

Sundry Photography/iStock Editorial via Getty Images

According to Ycharts Fundamental Charts, FedEx (NYSE:FDX) is down -10.8% YTD (which in this case matched the Morningstar data, which makes me more confident that it’s accurate) beating the SP 500’s YTD total return of -22.33% as of Friday, June 17th, 2022.

The last article written on FedEx in mid-April ’22 noted how cheap the stock was on a valuation basis, particularly the price-to-sales metric, which has traditionally been a good timing indicator for buying and selling the stock.

However, recent investor activism has also catalyzed FDX stock: while on March 29th, 2022, Raj Subramanian was named new CEO, as Fred Smith has been elevated to Executive Chairman, DE Shaw took a 1% position in the stock, and added two independent directors to the FedEx Board, which ultimately led to the FedEx Board increasing the recent dividend to $1.15 per share from $0.75.

Frankly the hike in FDX’s dividend by the Board was surprising: FDX’s free cash flow generation has been less than stellar for a while, which is usually the issue when you have a capital-intensive business like FedEx, where historically it’s been 50% to 100% of cash-flow-from operations. (Here’s one article written on FDX’s free cash flow topic.)

And therein lies the long-term issue for DE Shaw.

To really “unlock” value at FedEx the business model ultimately has to change to become less capital-intensive, include better margins (typically anytime the operating margin hit 10% – 12% at FDX, it’s time to sell the stock) and a more consistent, stable dividend – not to mention the lack of any meaningful share repurchase program, which could be an effective tool to return shareholder value given the cyclicality of the business.

Looking at FDX’s EPS and Revenue estimate revisions

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FDX EPS estimate revisions (IBES data by Refinitiv )

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FDX revenue estimate revisions (IBES data by Refinitiv )

Looking at the 2nd table first, FDX’s revenue revisions for 2023 and 2024 (this report Thursday night will be for fiscal Q4 ’22 so fiscal 2022 is in the books, so to speak) are still higher, albeit at a modest pace.

With recession talk in Europe and lately the US it’s no surprise that analysts are in no rush to positively revise EPS or revenue estimates.

While FedEx has a fuel surcharge to protect margins for jet truck fuel price increases, the fact is it’s likely hard to get a perfect hedge when gasoline has risen as much as it has the last two months.

It’s more comforting to see the higher revenue estimate revisions than it is disconcerting to see the pressure on forward EPS estimates right now since FDX, UPS, and the other carriers are still working off the incredible surge and then the slowdown in ecommerce and overnight deliveries.

Valuation

When FedEx reports this coming Thursday night after the close, the Street consensus is expecting $6.87 in EPS on $24.5 billion in revenue for “expected” year-over-year growth of 37% and 9% respectively. For Q1 ’23, the current Street consensus is expecting $5.20 in EPS on $23.7 billion in revenue for expected year-over-year growth of 19% and 8%, respectively.

Full year ’23 estimates are $22.18 in EPS on $97.9 billion in revenue for expected yoy. growth of 10% and 5% respectively, with FDX’s revenue growth averaging about 8% growth per year over the last 10 years.

AT $230 per share, FDX is trading at 9x average EPS from ’23 through ’25, with expected EPS growth averaging 7% for the next three fiscal years.

At 8x cash-flow and 18x free cash flow, the stock looks reasonable, but FDX free cash flow can vary wildly, since small changes in revenue can lead to big changes in EPS and free cash generation.

The valuation metric I put a lot of weight on for FDX is the price-to-sales metric for the transport giant: FDX’s current price to sales metric today is 0.65x which makes the stock more of a buy than a sell here and then once it gets close to 1x sales or revenue, FDX becomes a better sale.

Again, all this is contingent on what DE Shaw can unlock from the current Express, Ground and Freight operations.

Summary / conclusion

FedEx is one of client’s largest industrial holdings this year, in a tough tape, but there is likely more upside with FDX given DE Shaw’s activism, although it won’t likely happen suddenly. This may take some time.

I’ve been modeling FedEx since the late 1990’s when I had to argue with one of the investor relations reps that I wasn’t a mole and he could safely put me on the email list to which to send information. (It was really humorous: apparently FDX’s investor relations department was being regularly hassled by some investor or analyst and this FDX employee thought I was fronting for this person to get info on the company.)

Anyway, the point being that since the late 1990’s FedEx Express has always had trouble “leveraging” the Express unit, meaning revenue growth typically outpaced operating income growth for the giant. that means that the business is likely labor intensive and it’s not nearly as efficient as Ground.

FedEx Express typically generated almost half of FDX’s revenue every quarter, but only 40% of it’s operating income. Contrast this with FDX Ground, which typically generates 35% of FDX’s revenue, but generates 50% – 55% of its operating income every quarter.

In the last 11 quarters, granted these were COVID quarters, FDX Express only managed to leverage revenue growth in two of those quarters.

That may be where DE Shaw focuses his attention.

I think there is more upside for the stock and this fiscal Q4 ’22 is typically one of the strongest quarters every year, but let’s see what management says on the call. Europe was a mess with TNT, and now with Ukraine that can’t be a growth region, but let’s see if FDX can hold serve in old world Europe.

The stock is still cheap and the presence of DE Shaw should only help to unlock more upside.

Clients currently have a 1.5% position in the stock, and if the opportunity presents itself, it’s likely more would or could be bought.



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