12/22/14 10:00:05 AM
FOCUS STOCK OF THE WEEK
FEDEX CORPORATION (FDX)
FEDEX CORPORATION : (FDX)
This week's focus stock of the week is FedEx Corp. (FDX $176.19), which carries S&P Capital IQ's highest investment ranking of 5-STARS, or Strong Buy. We expect this global express delivery company to benefit from increasing online B2C (Business-to-Consumer) and B2B (Business-to-Business) shipping. In particular, we expect strong holiday online shipping after a record year in 2013. We think that volumes and pricing in the fourth quarter are likely to be strong. Margins over the next two years should benefit from a profit improvement and restructuring plan that is likely to gain significant traction this year.
In addition, we see overall transportation demand increasing over the next year on an improving U.S. economy and some improvement in other regions of the world. Finally, we see falling oil prices as a near term catalyst, as FDX should benefit from a mismatch in its fuel surcharge when oil prices are falling.
FDX provides global time-definite air express services for packages, documents and freight in more than 220 countries, and ground-based delivery of small packages in North America. In addition, the company offers expedited critical shipment delivery, customs brokerage solutions, less-than-truckload (LTL) freight transportation, and customized logistics.
FedEx Express (59% of total revenues in FY 14 (May)) is the world's largest provider of guaranteed express delivery services and FedEx Ground (25% of total revenues in FY 14) is North America's second largest ground package delivery company. FedEx Freight (13% of total revenue) provides regional and interregional less-than-truckload (LTL) freight service throughout the U.S. FedEx Services accounted for the remaining 3% of FY 14 revenues.
The company is expected to report fiscal Q2 results on December 17, and we expect revenue growth of about 5% for the quarter with operating margin improvement driving EPS growth of about 43%, to $2.24. We expect results to benefit from strong domestic express and ground volumes and margins, and improving international volumes and yields.
We also think near term results could benefit from the recent drop in oil prices. FDX charges customers a fuel surcharge, so falling oil prices will eventually result in lower costs for consumers, but when oil prices fall rapidly, like they have done of late, there is usually a timing mismatch between the pace of the drop in fuel costs and when that drop is passed on to customers. We think that could be a near term catalyst for improved EPS beyond consensus estimates for fiscal Q2 and Q3.
After rising 12% in 2013 to a record $56.1 billion, e-commerce sales will likely rise 16% in 2014, to $61 billion, according to a forecast from CommScore, an internet analytics company. In line with this forecast, CommScore also reported that Cyber Monday recorded 16% e-commerce growth and the first 38 days of the holiday season (through December 8) saw 15% total growth. S&P Capital IQ believes that FedEx is likely to be a leading beneficiary of this growth, as the company is a facilitator of both B2C as products are shipped to consumers over its network and B2B as inventory is stocked on customer shelves and in warehouses.
For FY 15 and FY 16, we expect revenues to grow about 5% in each year, as FDX benefits from market share gain on the ground side of the business and improving volumes and yields on the express side. In May 2014, FDX announced a shift to dynamic weight pricing, which takes into account not only weight but also package dimensions, which we think will aid overall pricing over the next year.
Margins are likely to benefit from higher volumes as well an ongoing restructuring program, as FedEx realigns its network, improves efficiencies and technology and retires older, more expensive to operate, aircraft.
We see EPS growth of 36% in FY 15, to $9.15, up from operating EPS of $6.75 in FY 14. For FY 16, we see further 21% growth, to $11.04.
Our 12-month target price of $240 values the shares at 21.7X our FY 16 estimate, in line with the company's ten-year historic range on this metric. It also puts the valuation closer in line to its closest peer, United Parcel Service (UPS $110.13 ****). We think the valuations of these two companies are likely to continue to converge as we think FDX is likely to grow revenues and EPS faster than UPS and we expect FDX to improve its metrics such as return on assets and return on equity closer in line to its major peer. We also think both companies are likely to see valuation expansion over the next year on an improving U.S. economy and strengthening transportation demand.
Risks to our recommendation and 12-month target price include a weaker U.S. and global economy than we currently forecast, a price war with UPS, or a sharp rise in oil prices that would affect transportation demand. FDX also faces several challenges in court to its independent contractor model, which, if successful, would lead to higher labor costs.
S&P Capital IQ's views on stocks are constantly re-evaluated. Please refer to our most recent publication on this stock to see our current view.