2023-09-07 04:45:52 ET
Summary
- FedEx's extensive global reach and economies of scale solidify its competitive edge.
- FedEx ranks as America's second most trusted B2B brand, bolstering its customer loyalty and market position.
- FedEx's cost reduction plan aims to improve margins as economic challenges ease.
- FDX could offer an 8% CAGR over five years, but better market opportunities exist.
Investment Thesis
In my opinion, FedEx ( FDX ) is a stock to hold for now, given its solid fundamentals but uncertain economic outlook. The company is competitively strong and has been proactive in addressing financial challenges. However, its current market valuation doesn't provide much of a safety net, particularly in light of potential recession risks. Even though FedEx has the potential for an 8% annual growth rate over the next five years, there might be better investment options with a more favorable risk-reward balance. Until there's more clarity on the economic front or the stock becomes more reasonably valued, I consider FedEx stock a hold.
Company Overview
FedEx, in my opinion, stands out as a global logistics leader with a diverse range of services. Through its subsidiaries like FedEx Express, which focuses on rapid international shipping, and FedEx Ground, catering to North American small-package delivery, the company has carved a niche for itself. Additionally, FedEx Freight handles less-than-truckload shipments, while FedEx Office offers business services.
At its core, FedEx's business model emphasizes speed and reliability. They use a hub-and-spoke system, where packages are centralized at key hubs before being dispatched. This approach, in my view, not only ensures efficiency but also allows FedEx to deliver timely services across 220+ countries. The company's use of technology for tracking and optimization further enhances its customer experience.
However, FedEx isn't without competition. Major players like UPS as well as Amazon ( AMZN ) venturing into logistics, the competition is intensifying. Yet, I believe that FedEx has a firm position as a leading player in the logistics industry.
FedEx's Market Dominance and Strategic Advantages
From my viewpoint, the logistics and delivery industry is largely dominated by FedEx and UPS, with FedEx holding a 47.78% market share as of Q2 2023. This near-duopoly, which leaves only a small fraction of the market to other players, is a testament to the scale and efficiency of these giants. In this context, FedEx's extensive global operations, covering over 220 countries, give it a unique competitive advantage. The company's economies of scale are particularly noteworthy; they allow FedEx to distribute fixed costs over a large number of shipments, thereby reducing the average cost per package and increasing profitability.
Furthermore, the scale of FedEx's operations acts as a significant barrier to entry for new competitors. The capital required to achieve a similar level of efficiency would be prohibitively high, making it difficult for new entrants to pose a serious threat. The company's versatile fleet and international reach are key assets that enable it to optimize cost structures. In my opinion, this not only limits the scope for price competition but also provides FedEx with the flexibility to plan its operations more predictably. The presence of Amazon Logistics has not significantly disrupted the market dynamics, which remain favorable for FedEx. The company's economies of scale continue to reinforce its competitive position, allowing it to cater to diverse customer needs while maintaining cost advantages. This highlights the resilience and competitive strength of FedEx in a challenging industry landscape.
FedEx's Brand Strength Secure Its Competitive Edge
In my view, FedEx's brand strength is a significant asset in the competitive logistics industry. The company's reputation for reliability and customer service has helped it retain a strong customer base and attract new business. A survey study conducted by Sage Frog Marketing Group further underscores this point; FedEx was ranked as America's second most trusted business-to-business brand, trailing only Amazon ( AMZN ) but ahead of other major brands like Google ( GOOG ) and Johnson & Johnson ( JNJ ). This high level of trust fosters customer loyalty, making many individuals and businesses stick with FedEx for their long-term shipping needs. In my opinion, this not only benefits FedEx in terms of consistent revenue but also serves as a barrier to entry for new competitors. In summary, FedEx's strong brand and focus on customer satisfaction give it a competitive edge that is hard to ignore.
Navigating Financial Headwinds
In my view, the financial outlook for FedEx over the next year appears challenging, especially considering the recent negative trends in its key financial metrics. For Q4 2023 , the company has seen a 10% YoY decrease in revenues, a 28% YoY reduction in adjusted EPS, and a 21% contraction in adjusted operating income. I think the primary factors contributing to this downturn are the broader economic slowdown, coupled with rising interest rates and inflation, which have resulted in lower shipping volumes.
In my view, FedEx faces financial hurdles in the near term. Two key issues are high fuel prices and a lack of delivery drivers, both affecting operating margins. The company is also seeing fewer shipping volumes in all categories including an 8% YoY decrease in domestic packages, a 3% YoY decrease in international exports, a -2% YoY decrease in the Ground segment and a 17% YoY decrease in the Freight segment. While it appears that the FedEx Express segments and the FedEx Ground segment has slowly been in recovery over the past 6 months, while FedEx Freight is yet to show any strong signs of recovery. As a result, this creates a tough outlook for earnings in the next year. If we do enter a recession in the next twelve months, I expect the volumes for all segments at FedEx to suffer and maintain negative YoY volume growth.
Strategic Cost-Saving Measures
In my view, FedEx is taking strategic steps to mitigate its financial challenges through the implementation of its Cost Reduction Plan. The plan has several key components aimed at improving the company's financial health. For instance, FedEx has more effectively aligned its flight hours with demand, resulting in a 12% reduction in global flight hours in Q4 FY23. This is part of a broader cost reduction effort that delivered a $2 billion YoY reduction in operating costs in the same quarter. Specific actions taken include the permanent retirement of 18 aircraft, including 12 MD-11s, in Q4 FY23. The company has also been aggressive in managing its headcount and hours. Additionally, FedEx has realized benefits from its DRIVE transformation program, which aims to improve operational efficiency. These strategic moves indicate that FedEx is proactively addressing its financial challenges, focusing on cost reduction while still aiming to meet customer and employee commitments. In my opinion, as the economic challenges lessen, there's a good chance that operating margins could exceed prior levels, leading to a significant increase in earnings because of these cost-saving measures.
Financial Analysis
Over the past 5 years, the company has demonstrated solid financial performance. Its revenue has shown a consistent and strong growth, increasing from $65,450.00 million in 2018 to $90,155.00 million in 2023, representing a compound annual growth rate ((CAGR)) of approximately 6.6%. The earnings per share ((EPS)) has been relatively flat, decreasing slightly from $16.79 in 2018 to $15.48 in 2023, reflecting the company's recent inability to prevent operating margins from decreasing as a result of higher operating expenses. It is expected that operating margins will eventually expand due to the Cost Reduction Program being implemented as well as fears of a recession eventually passing.
As of the most recent quarter, the company reported cash and cash equivalents of $6,856.00 million . The company's total debt stands at $19,728.00 million, a manageable amount that could be paid off entirely with about 4 years’ worth of 2023 free cash flow. The company's current ratio, a measure of its ability to cover short-term liabilities with short-term assets, is 1.37, which is generally considered healthy as it is above 1.
As previously mentioned, I expect the upcoming few quarterly earnings results to be tough due to reduce overall package volume as a result of macro-economic headwinds dampening economic activity and higher labor costs and fuel costs.
Looking beyond the next 12 months, assuming a return to favorable macroeconomic conditions, the company, in my view should be able to expand margins as a result of the implementation of the Cost Reduction Plan.
Valuation
When considering valuation, I always consider what we are paying for the business (the market capitalisation) versus what we are getting (the underlying business fundamentals and future earnings). I believe a reliable way of measuring what you get versus what you pay is by conducting a discounted cashflow analysis of the business as seen below.
FDX current TTM Cashflow per Share as of Q4, 2023 is $10.45. Once a favourable macro environment returns, as cash flows normalise and margins expand from the Cost Reduction Plan, I believe that FDX should grow conservatively at 13% annually for the next five years. Therefore, once factoring in the growth rate by Q4 2028 FDX’s Cashflow per Share is expected to be $19.25. If we then apply an exit multiple of 16, this infers a price target in five years of $373.35. Therefore, based on these estimations, if you were to buy FDX at today's share price of $256, this would result in a CAGR of 8% over the next five years.
Therefore, if you believe an 8% annual return is acceptable you may want to consider a position in this stock, however in my opinion there are better opportunities in the market that present a greater return profile, hence I have this stock as a hold. While FDX has a strong business model and is a market leader, I think with recession risks looming and at this current valuation, no margin of safety is achieved. Given these factors, FDX will stay on my watchlist, as I hope the market will offer a more favorable investment opportunity in the future.
Conclusion
FedEx's extensive global operations and economies of scale give it a strong competitive advantage in the logistics industry. This is further reinforced by its ranking as America's second most trusted B2B brand, which speaks volumes about its customer loyalty and market position. Despite facing economic headwinds, the company has been proactive in implementing a Cost Reduction Plan aimed at improving margins. This plan, along with the benefits realized from its DRIVE transformation program, positions FedEx well for future growth. Financial projections suggest that FDX could offer an 8% Compound Annual Growth Rate over the next five years. However, given the current valuation and looming recession risks, it may not provide a sufficient margin of safety for investors. Therefore, while FedEx remains a market leader with a strong business model, there may be better investment opportunities available in the market for higher returns.
For further details see:
FedEx: Strong Business But Risky At Current Valuations