FedEx Corp. (FDX) has been a stark reminder to investors that it is a market of stocks out there. While the broader averages have treaded water, FedEx has taken a vertical plunge.
What ails FedEx?
We traditionally associate 20% declines as a bear market in the broader averages and FedEx has delivered 2X that, just in the past 12 months. As we browse Seeking Alpha, there are some compelling bull and bear cases. In general, the bulls have argued that the stock is cheap on forward earnings multiple, while the bears have pointed out that free cash flow has been consistently negative and Amazon (AMZN) might be a serious threat to the business. So far, the bull thesis has failed, rather appallingly. A key problem with trying to buy FedEx with the low multiple in mind is that the earnings are refusing to have any kind of bottom.
This has resulted in the same argument being made on the way down.
FDX is crazy cheap at 12X earnings of $17 (at $204), December 2018.
FDX is crazy cheap at 12X earnings of $12 (at $144), September 2019.
We are not making fun of that logic as FedEx has certainly surprised on the downside more than almost anyone expected in the midst of a strong economy. Bears have got this right till now as the falling profits and cash flow have further compounded FedEx’s free cash flow promises.
Bears now have the firm upper hand with no end in sight to FedEx’s woes and recessionary fears further panicking the beleaguered bulls.
The longer term bull argument
Before we give you that, if you want a rather safe play on FedEx’s issues, we highly recommend heading to this stock which has been beaten alongside FedEx but is really not going to be impacted by it. With that out of the way, let’s focus on FedEx. The first question is whether something is fundamentally broken with the company. We think the answer is clearly no. The two commonly cited longer term issues, AMZN moving away and trade worries, do exist, but both are shorter term in nature. In the case of AMZN, FedEx had to go out of their way to show that unless they rescaled their graphs you could not even tell how little they cared about AMZN.
Source: FedEx Presentation
Yes, AMZN could also compete with FedEx, directly, and that should be part of every investor’s long-term threat assessment, but the most likely scenario continues to be that AMZN will focus on its retail business and not try and take on FedEx directly. We also think the market will grow enough to accommodate another player if needed. We also believe the trade issues are likely to resolve sooner rather than later and FedEx will dust off its 2% exposure to China like it never even happened.
Two percent of FedEx’s revenue can be attributed to business between China and the U.S., according to a company spokesperson. FedEx has about 9,500 employees in China, according to its website.
FedEx operates 220 flights per week in China at five Chinese airports, including the “mini-Memphis” hub in Guangzhou and the new Shanghai hub it invested more than $100 million in.
“FedEx values our business in China,” the company said in a statement Saturday. “Our relationship with Huawei Technologies Co. Ltd. and our relationships with all of our customers in China are important to us.”
Worldwide, FedEx has more than 450,000 employees and serves more than 650 airports.”
Source: Commercial Appeal
The second question to address is whether FedEx is a good value today. Investors, having been burned by FedEx’s earnings projections which have matched the decline in the stock, are obviously feeling reluctant to use that as a gauge. After all, they certainly don’t want to be saying FedEx is crazy cheap at 12X earnings of $8 (at $96). We think that the answer is more difficult to reach today than it has been in the past, simply because FedEx is going through a supercycle of capital upgrades and is reluctant to pull back. We saw this when Scott Group, who appeared to have lost all strength, was basically just begging for guidance from Alan Graf (CFO of FedEx).
Hey, thanks. Afternoon, guys. So this is I think, the fifth straight quarter of either missing or cutting – missing numbers or cutting guidance. Are you approaching guidance any differently meaning taking a more conservative approach here. Anything that you think that gives you some confidence or us some confidence that this is the final cut?
And then I separately just want to understand, Raj, you said we’re doing everything we can to reduce capital spending, and yet, CapEx is staying unchanged and now flat next year as well. So can you help us understand that? I know that’s two questions, but we need some hand holding here I think.
Scott, I’ll take on both. The lack of being able to hit our forecast is just the difficulty associated with forecasting in this environment. I don’t think, we’ve been too aggressive based on what we knew at the time. You have noticed that, we’ve widen the range this year and I did mention that our current point estimate is higher than the midpoint of that range, so we’ve given ourselves a little bit more downside. I also said that we don’t – we’re not expecting any additional weaknesses in the international macro environment from where we are today, which is a wild card. So I just want to point those things now to.
As far as CapEx, trust me, FY 2021 would be a lot higher than $5.9 billion had we not started cutting already. I think there are two things that are really important to understand. And number one is, we have to continue to modernize the fleet. The profound impact of the lower costs and higher reliability of the new twins is just remarkable. And we’re going to continue to do that, we’re going to maybe stretch it out a bit, but not much because the faster we can get those in there, the faster we can enjoy those benefits.
Source: FedEx transcript, emphasis ours
The $5.9 billion, while scary for the bulls, does underscore an important point. FedEx is spending a lot to upgrade their asset base, and assuming you don’t think that they have suddenly lost their minds, it will pay off.
While the cyclicality of their returns are not easy to see on shorter time frames, we can see it on longer time frames. Return on Assets, or ROA, for example, has fluctuated between 1% and 8% as FedEx goes through its profitability cycles. At 1%, we appear to be getting close to trough in our opinion.
On the flip side, with all of this large spending in place and a largely expanded asset base, can you imagine how much will be generated at 8% in the next cycle? Another way to look at this is to see the ratio of FedEx’s market cap to its capital expenditures. We view this as a proxy for how badly the market is punishing the stock for investing in itself.
We are close to troughing levels again on this measure (near 7) in our opinion. One final measure we would look at is the price to sales ratio. This does make an implicit assumption that earnings and margins can fluctuate a lot, but the revenues are a better measure of longer term value. Based on that, FedEx has approached similar levels 5 times in the past 2 decades.
Each was a good buying point, although the 2008-2009 selloff went much further than we would have expected. This appears as a longer term value opportunity and investors buying here likely made good risk-adjusted returns.
We looked at FedEx through 3 unconventional measures and we think cumulatively they reflect the strong underlying value in the company. At this point, these measures agree with the earnings metric unlike at the earlier price peak a year back where we stayed out of the stock. Yes, things do look bad today, and yes, they can get worse, but when the time comes to buy, no one wants to. That is precisely where the most compelling opportunities set up.
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Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in FDX over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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