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Is Fedex A Good Investment?

FedEx (NYSE: FDX), a leader in the transportation, e-commerce and business services with more than 300,000 employees and annual revenues of $42 billion, reported earnings this morning. Revenue was up 9% year-over-year to $10.6 billion, operating margins was up 4.1% y-o-y to 7.7%, and net income was up an impressive 126% y-o-y to $521 million. Reported EPS of $1.55 beat consensus estimates of $1.35, excluding the one-time reserve for a legal matter involving FedEx Express. We found the volumes from the Domestic Express business very disappointing but volumes from the International volumes did quite well. The reality is that the trend seems to be declining domestic volumes but increasing international volumes with the latter benefiting from more global trade. Though growth in the international arena is great, since international flights cost more than domestic flights i.e., aircraft, personnel required, landing fees, etc. this will likely compress overall margins. We found guidance uninspiring with a fourth quarter range of $1.75 to $2.00 per share and FY 2012 range of $6.35 to $6.60 per share. Guidance came in 5.3% below consensus estimates of $1.98. Management did not elaborate much on those figures. Overall, the results were mixed and the market was not pleased; as of midday the stock is down 4.5%.

FedEx Corporation (NYSE:FDX)

Summary by Segment:

Express: Total average daily package volume grew 1.1% y-o-y. Envelope volume was down 7.9% y-o-y—we think this is a secular downward trend that will persist. International Domestic volumes were a robust +50.7% y-o-y, which was a positive surprise.

Ground: Revenue of $2.5 billion and better-than expected operating margins of 18.8% (consensus was 17.1%). Average daily package volume grew 5% y-o-y. There are opportunities to increase margins if management works to increase efficiencies.

Freight: Missed expectations earnings expectations badly with an operating loss of $1 million (consensus was $24 million). Revenue held up at $1.2 billion. Until FDX can turnaround this poor performance, it will likely be an overhang on the stock.

Although EVP and CFO of FDX, Alan Graf, said FDX is “pleased with the improved performance at FedEx Ground and FedEx Freight…and evaluating actions to adjust our FedEx Express U.S. domestic network capacity and improve efficiency,” we remain concerned over a few points: (1) growth in costs have been outpacing growth in revenue per ton (2) FDX employs a fuel-intensive business model— consumption at FDX is approximately 60% more than United Parcel Service (NYSE: UPS). Upgrades to a more fuel efficient fleet should help, but burning 300,000 gallons of jet fuel per quarter at current prices is not exactly great for cost containment. (3) Capex has been increasing at about 10% a year for the past 10 years. Almost half of the capital budget can be attributed to its aircraft fleet. We expect the upcoming 727/757 re-fleeting project and additional 777 planes to reshape the current fleet, which will be a significant capital outlay in attention to the maintenance capex required for its aging fleet.

In terms of news from competitors, UPS announced an agreement to acquire Amsterdam-based TNT Express for EUR9.50 a share, valuing TNT at $6.8 billion. The acquisition will bolster UPS’s European and Asian and gives it a foothold in Brazil and Australia and will force FDX to compete more effectively on the International front. Expeditors International of Washington (NASDAQ:EXPD) and UTi Worldwide (NASDAQ: UTIW) also operate in the logistics industry, managing air and ocean freight, vendor consolidation, and cargo distribution but do not operate on the same scale that FDX and UPS do. EXPD missed fourth quarter earnings and UTIW is still in the process of restructuring, benefits from which we probably won’t see until FY 2014, so we do not recommend either of these freight forwarders.

We see positives including the parcel sector’s leverage to global trade, which has been growing at a mid-single digit clip over the past decade. Moreover, DHL’s 2009 exit from the domestic US market will give FDX and UPS opportunities to increase volumes and increasing pricing power. The stock is also trading at a ~21% discount to its trailing 10-year average NTM P/E multiple. Mason Hawkins, Jason Capello, and Robert Bishop all own some FDX, but we don’t love the stock and believe there are better places to put your money (see more on Top Hedge Fund Pick ).

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