FedEx: Stock Price Risks (NYSE: FDX)

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Introduction

FedEx (NYSE: FDX) has grown strongly over the past 20 years, but since the corona crisis its strength has waned and it continues to lag the S&P500. The low price may look like a potential buying opportunity, but there are some risks looking for FedEx.

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Data by YCharts

Quarterly results were below expectations and FedEx lowered volume expectations. The Treasury bond yield spread was less than 0, and from a historical perspective, this indicates an emerging recession. The accelerated share buyback is a temporary catalyst for the upward movement of the stock price, but there are many risks to the stock price. Therefore, I think the stock is a sell.

Quarterly results below expectations

In the first quarter of the current fiscal year, revenue rose 5.6%, but earnings per share fell 21% year-over-year. Earnings per share were well below analysts’ expectations, which had forecast an increase of more than 18%. FedEx also lowered its ground volume forecast due to a drop in the number of customers shipping packages with FedEx.

Quote from the revenue report:

Consolidated first quarter operating results were negatively impacted by weak global volumes which accelerated in the final weeks of the quarter due to weakening economic conditions. Additionally, results were negatively impacted by service issues at FedEx Express. Yield improvements, including fuel surcharge increases, more than offset the lower volume, resulting in higher revenue for the quarter.

In response, the company implemented cost reduction measures and continued to focus on yield management and revenue quality to mitigate the effect of volume declines. However, the impact of cost reduction measures was less than the decline in volumes and operating expenses remained high relative to demand.

Over the past two quarters, US GDP has shrunk, pushing the US into recession. A decline in GDP affects FedEx because consumers spend less. Still, I expect an emerging recession within a year as the spread between 10-year and 3-month interest rates is currently below 0. Historically, this means the US could enter into recession from now and a year from now. A recession could mean FedEx’s earnings forecast is in jeopardy. Still, analysts expect earnings per share to average $18.25 in fiscal year 2024. Given that the yield spread has turned inverse, I expect future earnings to be less rosy than analysts predict.

The accelerated share buyback program is a temporary catalyst

FedEx has always been shareholder-friendly, but that hasn’t resulted in a strong rise in its stock price from 2020. FedEx pays dividends and buys back its own stock. Currently, the dividend is quoted at $4.60. At the current share price of $158, that means a dividend yield of 2.9%.

Repurchasing shares is a tax-efficient way to return cash to shareholders. When the United States enters an economic recession, FedEx profits could decline rapidly. FedEx’s operating margin is very low compared to UPS’s, so the drop in profits can be sharp (FedEx operating margin = 5%, UPS operating margin = 13%).

FedEx is accelerating stock buybacks totaling $1.5 billion in stock. On the current market capitalization, this gives a redemption yield of 3.7%. The share buybacks are expected to be completed before the end of FedEx’s fiscal year, which will be in May 2023. The prompt buyback will limit further decline in the share price until the next fiscal year. In the short term, we can expect a rise in the share price, but I expect it to be temporary given the economic risks.

In recent years, FedEx has been shareholder-friendly by introducing a large stock buyback program in addition to a small dividend. In total, FedEx has paid out more to shareholders than the free cash flow generated from 2018 to date. The cash returned to shareholders was financed by their free cash flow, but also by debt.

FDX - SEC Cash Flow Highlights and Author's Own Calculations

FDX Cash Flow Highlights (SEC and author’s own calculations)

As a result, their long-term and short-term debt rose sharply to $20 billion, or more than 50% of their market capitalization. FY2022 free cash flow was just $3 billion, making debt a factor of 7 of their free cash flow. That’s a lot if free cash flow declines in a coming recession.

Online evaluation with the competitor, but take a look at the UPS competitor

The recent decline in stock prices provides supportive valuation measures. In the following chart, I show company value versus EBIT, as this compares both market capitalization, debt, and cash to EBIT. Cash and debt are an important part of the valuation metrics because FedEx has distributed more cash to its shareholders over the past four years than it has received in free cash flow.

Due to the coronavirus crisis, EBIT fell sharply, causing the EV/EBIT chart to quote at infinity. Therefore, I showed the October 2020 chart including the 10-year median. FedEx offers attractive quotes at a 20% discount to historical EV/EBIT. But the valuation can fluctuate wildly if FedEx makes less profit. A low valuation is no reason to buy the stock.

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Data by YCharts

FedEx’s closest competitor is United Parcel Service (UPS). UPS also quotes in line with FedEx’s rating. Therefore, UPS is also a stock to take a closer look at. In fact, UPS’s high profitability makes the stock very attractive.

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Data by YCharts

Conclusion

The sharp decline in the stock price might look like a good buying opportunity, but some risks remain. FedEx is repurchasing $1.5 billion of its own shares on an accelerated basis, representing a repurchase yield of 3.7%. The dividend has been growing steadily for years, averaging 19% per year over the past 10 years. The EV/EBIT ratio is below the 10-year median, so the stock’s valuation is attractive and in line with its competitor UPS. FedEx released a quarterly report well below analysts’ expectations. Earnings per share fell 21%, while analysts expected EPS to rise 18%. Their lower volume expectations are creating additional pressure in the near future. Still, the results were predictable as US GDP declined over the past two quarters. The yield spread has reversed and, from a historical perspective, this points to a recession within a year. I see the reverse yield spread as a gloomy outlook for FedEx. Therefore, I expect a bigger decline in FedEx stock price within a year.

Karen J. Nelson