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David G. Ross, CFA
Stifel Nicolaus
[email protected]

We hosted a conference call with Rob Martinez, CEO of Shipware, LLC, a parcel auditing and consulting firm, to dig deeper into the announced 2012 air and ground rate increases of FedEx (FDX; Buy; $82.14) and UPS (UPS; $71.07; Buy). Below are key takeaways for UPS/FDX investors.

2012 rate increases [are] “good news for [UPS/FDX] investors, bad news for shippers,” as increases are likely to stick due to lack of shipper alternatives, complexity of the pricing structure and carrier discipline.

Many shippers are still highly inefficient, in our opinion, so we believe there is opportunity for cost savings even with rising rates through modal optimization (mainly more ground, less air).

Carrier cost increases that require rate increases are mainly labor (UPS Teamster contract) and technology – UPS alone spends over $1billion per year on technology to improve the customer experience from ordering to tracking to delivery.

2012 air and ground rate increase averages are misleading, as above-average increases were taken on lighter-weight packages and below-average increases on heavier-weight packages. According to Shipware’s large client database, 87 percent of its clients’ shipments weigh less than 30 pounds. Ten percent weigh 31-50 pounds, and 3 percent [weigh] more than 50 pounds.

We reiterate our Buy rating on the shares of both parcel carriers.

William J. Greene, CFA
Morgan Stanley

Since FedEx’s last earnings update in September (which captured this summer’s volatility and uncertainty), a number of relatively constructive/bullish data points have emerged that give us confidence that FedEx’s [next] earnings report … will have upbeat commentary.

(1) On a macro level, the unemployment rate dropped below 9 percent to 8.6 percent, the lowest rate since March 2009. In addition, consumer confidence surprised investors with a large uptick in November, and early reports about consumer retail spending in November have been solid.

(2) Both International Air Transport Association and Airport Transportation Association of America October cargo data showed relative strength in Asia, which bodes well for FDX’s international airfreight.

(3) 3Q earnings reports across the LTL space were positive on strong pricing, which should bode well for FedEx’s efforts to turn-around profitability at Freight.

(4) UPS’ public comments on 3Q earnings (reaffirmed at our conference last week [in early December]) highlighted sequential volume strength in Asia and continued double-digit growth in Europe, despite macro volatility.

We expect the midpoint of FedEx’s FY12 EPS guidance to be ~$6.25 (close to current consensus). This would be a slight cut vs. the current mid-point of guidance of $6.50/share and below the implied EPS of $6.40/share based on our five-year sequential change analysis with our 2Q estimate. However, given macro uncertainty on GDP and fuel, we believe FedEx will be more conservative with its outlook.

That said, we would be surprised if a cut of this magnitude weighed on the shares because FDX’s current forward multiple of less than12 times suggests investors have already discounted the probability of a cut to FY12 guidance. This is a key reason we reiterate our OW rating on shares of FDX especially for investors who have a 12-18 month time horizon.

It is also worth noting that based on the bullish data points we outlined and historical seasonality it is possible that FedEx offers guidance well above both buy and sell-side consensus. FDX has a history of providing conservative guidance.

Thomas R. Wadewitz, AC
J.P. Morgan
[email protected]

Federal Express (FDX) stock has had a strong move up off of its low in late September … Valuation of FedEx at a P/E of 12.8 times on our CY2012 EPS estimate (versus an average historical-forward P/E range of 13 times to 21 times) reflects what we believe are low expectations and also concern about FedEx’s sensitivity to potential weakness in economic growth. Against this backdrop of low expectations, we believe there is room for meaningful upside in the stock if FDX delivers solid EPS performance over the next several quarters…

Looking beyond potential near-term noise from 3Q guidance, we believe that reward to risk is favorable for FedEx stock. We continue to rate FDX Overweight.