FedEx Stock has been a laggard. Here’s how he can catch up.
Founder Fred Smith, who came up with the idea for an overnight package delivery business as an undergraduate at Yale University, will step down June 1 as chief executive. of the company he founded 51 years ago.
The succession, with chief operating officer Raj Subramaniam, 56, at the helm, could be a bullish development if the new CEO takes a page from
United Parcel Service
(symbol: UPS) and emphasizes profitability rather than growth. Under Carol Tomé, CEO of UPS for the past two years, the rival has implemented a strategy called “better not bigger” that has worked well on Wall Street.
FedEx (FDX) shares are an inexpensive bet on higher margins, better earnings and greater free cash flow. Its shares, at $205.74, have been little changed since mid-2017, far behind the
S&P 500 index.
The stock looks attractive, valued at 10 times expected earnings of $20.45 per share in its fiscal year ending May and nine times estimated earnings of $22.61 per share in the next fiscal year ending in May 2023.
UPS, at $188, recoups 15 times estimated 2022 calendar earnings and is trading at an unusually large premium to FedEx. Recent weakness in FedEx and UPS stocks reflects concerns about the economy and consumer spending later this year.
“It’s extremely frustrating,” says Joe Fath, senior portfolio manager at T. Rowe Price, a major shareholder. “It’s crazy how low FedEx trades. This shows how little trust buyers and sellers have in the company.
Much of the frustration has to do with FedEx Ground’s low profit margins, which the company has widened dramatically over the past decade to take on UPS in e-commerce.
FedEx’s largest business, FedEx Express, which delivers packages by air overnight, grew more slowly than the ground business. The company also has a lucrative trucking business called FedEx Freight that could be worth a significant chunk of its market value, based on comparable public companies such as
Former Dominion Freight Line
Fath says it’s rare to find a company in what amounts to a duopoly with such a low valuation. FedEx has a 30% market share in its ground business, behind industry leader UPS. By comparison, America’s Big Four railroads operate as two duopolies east and west of the Mississippi River and trade for about 20 times their profits.
Activist investors could target FedEx, but it’s unclear whether such a campaign could garner enough shareholder support if Smith, 77, who owns 7% of the company, opposed it. It’s not easy to face a founder.
FedEx Ground’s situation received renewed attention after the company released its fiscal third quarter results in March. While overall earnings of $4.59 per share were in line with expectations and up 32% from a year ago, analysts were unhappy with ground operating margins, which rose 7.3%, compared to 8.8% the previous year.
FedEx has disappointed investors in recent years despite a generally favorable operating environment. Even higher fuel costs aren’t an issue, since FedEx is able to pass them on to customers. The company raised prices by around 6% at the start of 2022.
“The valuation is compelling,” said JP Morgan’s Brian Ossenbeck, which has an overweight rating and a price target of $282 for the stock. “Free cash flow has been challenged for some time, and investors want to see better capital deployment.”
|Company / Symbol||Recent Price||52 weeks. Switch||Dividend yield||2022E EPS||2022E P/E||2022E revenue (billions)||Market value (bil)|
|United Parcel Service / UPS||188.87||5.3||3.2||12.78||14.8||102.1||164.5|
*End of fiscal year in May; E=estimate
FedEx forecasts $3 billion in free cash flow for the current fiscal year, compared to $9 billion for UPS. FedEx has increased its capital returns to holders in the current fiscal year, repurchasing more than $2 billion in stock, or 3% of shares outstanding. It pays a 1.5% dividend, less than half of UPS’s 3.2% dividend, which has a 50% payout ratio. The free cash flow story should improve at FedEx in the coming years, given a moderation in capital spending.
Fath says investors are eagerly awaiting FedEx Investor Day in late June for an update on how the company plans to increase margins and profitability. The company aims for an operating margin above 10%. Lately it has been closer to 6%, while UPS’s is above 12%.
While there are structural reasons for the margin gap, including UPS’s more integrated network, FedEx also has plenty of room to close the gap. UPS is heavily unionized, while FedEx Ground is not.
Subramaniam, FedEx’s new CEO, has worked closely with Smith for more than 20 years and may not break much with the founder, who will continue to wield power as chairman. What the company may need is an injection of “new thinking,” says Fath.
UBS’s Tom Wadewitz noted in March that “Historically, FDX has focused on revenue and volume growth, and the change in leadership could mean an increased focus on revenue quality, margin operating and financial return performance”.
The FedEx opportunity can be summed up as follows: FedEx and UPS have similar annual sales, but FedEx only has a third of the market value of its main rival. FedEx is expected to have sales of $93 billion, while UPS is expected to have sales of $102 billion in 2022.
Whether it’s done by Smith’s successor or someone else, the FedEx/UPS gap should eventually close and shareholders should win.
Write to Andrew Bary at [email protected]