Thomas R. Wadewitz
We believe that Federal Express’ (FDX) medium-term story remains attractive with volume growth in International and Ground and margin expansion in Express and Freight (LTL) as key drivers of EPS growth. A gradual acceleration in domestic small package pricing also provides support for our positive medium term view.
Recent momentum in consumer activity (strong November retail sales) provides a positive indication for peak season results for both FDX and UPS.
We expect an in-line earnings report from Federal Express … when they report their 2QF11 results. The demand data we track for FDX’s Express business indicate that volumes in the quarter are likely to be in line with our forecasts while the move up in fuel is probably a modest headwind.
FDX stock has performed well since the late August low in the market (FDX is up 22% vs. S&P 500 17% since Aug. 31). We believe FDX’s medium-term story is on track, but there is probably near-term risk related to 3Q guidance.
We believe that FDX’s 2QF11 EPS is likely to be broadly in line with expectations (Consensus is $1.32 and our forecast is $1.30). Transport demand data in 2Q show that FDX’s Express volumes have likely been on track and the rise in fuel prices in 2Q is probably only a headwind of $0.04/share or less.
Airfreight data indicate FDX Express volumes are likely consistent with our 2Q forecast.
We believe the market will take the fuel revisions in stride and focus on the longer-term potential [of FedEx] where we believe growth of international Express and Ground should lead to both rising earnings and higher returns for shareholders.
Stepping back from near-term earnings, we believe the bigger story for FDX is the potential for the company to expand both margins and returns across the cycle. In a slide deck we published recently (“FedEx Can Deliver on Returns”), we highlight our analysis on the potential for near $9 in EPS and increased returns from International & Ground expansion.
While the latest air cargo data paints a mixed picture with some declining demand in the trans-Pacific trade lane evident, we believe low relative inventory levels could set the stage for a robust ‘peak’ package shipping season this November and December.
Total business and retail inventory to sales ratios remain below pre-recession levels. When combined with continued gains in retail sales, we believe if consumption patterns remain solid, businesses may be forced to utilize higher cost time-definite transportation options to fulfill any unexpected holiday demand over the coming months. We believe the set-up into this holiday season bodes well for the package integrators.
We see substantial expansion of earnings power at FedEx over the next several years. By far the largest opportunity is improving earnings at Express, which we believe is easier to achieve than many expect.
International Express remains highly profitable by our estimation. Domestic Express, where we see the largest opportunity, should benefit from pricing gains amid a shifting competitive landscape and reduced industry capacity.
William H. Fisher, CFA
FedEx hosted a well attended analyst meeting [recently] in Memphis, Tenn. – its first since 2007. Management was upbeat about its revenue, margins, and earnings prospects despite an anemic economy. Market share gains, growth in emerging markets, an intense pricing focus, and abating cost headwinds in FY12 will be keys to the company’s success.
FedEx’s flagship Express unit garnered much discussion as management continues to target double-digit margins in a time period that is “a lot faster than you think.” Management stressed that 60% of international traffic originates or terminates within the U.S. This illustrates how inextricably linked the two networks are.
With that said, in as late as 1999, FDX broke out international profitability, and based on our contribution analysis we surmise that FedEx Express’s domestic operations are marginally profitable today.
We also surmise that domestic yield improvements will be instrumental in pushing domestic profitability higher and achieving the double digit margin goal. Importantly, in our view, yield improvements will be a longer term secular tailwind, which should benefit both FDX & UPS.