FedEx Stock: Post-Earnings Pop, No Aberration (NYSE:FDX)

About a month ago, I wrote you an article entitled, “FedEx: An Industrial Stock Poised for Capital Appreciation.” A link to that article is found here.

That article was written in advance of the September 20 FedEx (NYSE:FDX) earnings release in mind.

Today, I’m writing you with brief post-earnings follow up.

Investment Thesis Intact

In the August 30 article, I highlighted two items I contended will lead the stock higher:

• A renewed focus on expense management by a new and transformative CEO

• An inevitable return of package volume growth

On September 20, FedEx management reported 1Q2024 earnings. The key messages are found on slide one of the earnings conference call:

Regarding expense management, results exceeded expectations. In turn, operating income and margins moved ahead smartly. Management is executing the first part of my thesis in spades.

On the other hand, package volumes remain pressured due to macroeconomics. While management has a great deal of power to control costs, their ability to generate sustainable incremental volume is limited.

Nonetheless, in spite of continued demand softness, the company posted excellent overall results; beating EPS expectations by a wide margin while missing the Street revenue forecast by less than one percent. Operating margins improved by 200 bps. 2024 fiscal year earnings guidance was raised.

Wall Street’s reacted by driving up FedEx shares by 4.5 percent despite a pitiful tape.

Several brokerage houses increased target prices.

For those seeking more detail, the earnings press release and conference call slide deck are found here.

Let’s break it down.

Expense Management

I believe the catalyst for the sharp results is new CEO Raj Subramaniam.

Subramaniam is intent upon streamlining the company and cutting excess post-COVID capacity and costs. The results are clear:

Year-over-year total opex is down 8.6 percent. Excluding business restructuring and optimization expenses, YoY opex fell 9.0 percent.

Furthermore, management promises two 2024 significant, related actions will amplify results:

• The One FedEx initiative is tracked for completion by June 2024. This work will combine FedEx Express, FedEx Ground, and FedEx Services into one organization. FedEx Freight will remain a separate business unit.

• The FedEx DRIVE program will eliminate $1.8 billion expenses permanently.

Management also reiterated capex intensity will abate. An aircraft and facilities refresh cycle is winding down. FY2024 budgeted capital is $5.7 billion versus $6.2 billion and $6.8 billion in FY2023 and FY2022, respectively.

What Does It Mean to Investors?

FedEx business model is predicated upon span, scope and service. Operating income and margins are key resultants. After the fiscal year 4Q2023 earnings release, management indicated this year’s adjusted operating income would total $6.2 billion.

The new indication is $6.3 billion.

Using management’s FY2024 current guidance for flat revenue, this suggests a 7 percent operating margin. As noted in my previous article, historically, FedEx is on point when margins range between 7 percent and 8 percent.

Mr. Subramaniam and staff are saying we’re on the doorstep. And that’s without the benefit of strong package volume growth.

What About Package Volume?

Please note that my thesis focuses upon package growth, not necessarily package revenue.

Why?

Primarily, package volume is a barometer of the health of domestic and global economy and resultant demand.

Here are some salient management comments from the September 20 conference call:

CEO Raj Subramaniam offered these remarks:

Yes, we enjoyed some upside from UPS and Yellow. But as Brie mentioned, it was a soft market. There were some offsets there and yield pressure in the soft market.

The demand environment remains uncertain, and we are being prudent in our financial projections, given that environment.

CFO Brie Carere added encouraging color, but it was muted:

Across Ground and Express, volumes improved sequentially [but not by much], aided by the threat of a strike at our primary competitor. We onboarded new customers who valued our service and were committed to a long-term partnership with FedEx. As a result, we added approximately 400,000 in average daily volume by the end of the first quarter and the team did an excellent job focusing on commercial Ground business acquisition.

At FedEx Freight, revenue was down 16%, driven by a 13% decline in volume. We experienced significant improvement in volume in August due to Yellow’s closure. Freight benefited from approximately 5,000 incremental average daily shipments at attractive rates as we exited the quarter.

…We expect to continue benefiting from this quarter’s market share gains throughout the fiscal year. We anticipate improved year-over-year growth rate, especially late in the fiscal year, albeit within a muted demand environment.

Indeed, the volume metric hasn’t turned yet, but there are clear green shoots. A picture tells a thousand words:

I submit FedEx package volumes have bottomed or are very close to the bottom. The trends are unmistakable.

Meanwhile, package yield (combining packages and price) should improve as a function of greater volume; volume permits lower incremental costs. In addition, on January 1, 2024, there is a shot in the arm upcoming: FedEx is raising rates by 5.9 percent.

Responding to a question about whether the price increase is appropriate, Brie Carere said,

I think the first and foremost is the pricing market has been very rational for the last several years. I think it’s also important to remember that we are the price leader. In every market segment in the domestic market, we actually lead on price and that’s because we have the better value proposition. We’ve got seven days a week, and we’ve got picture POD and we’ve got the faster network. So, as I think about responding to the current competitive pressure, my job is to make it very difficult for our primary competitor [UPS] to win back that share.

Pay Attention to Operating Leverage

I like to boil down broad corporate initiatives into a few easily generated, easily understood metrics. Once I’ve found useful for cyclical growth companies is “operating leverage.” It’s utilized by other companies; one notable user is Bank of America (BAC).

Operating leverage may be defined as year-over-year delta revenue less year-over-year delta total operating expense.

If a company grows revenue faster than expenses, operating leverage is positive. If a company records declining revenue but cuts opex at a greater rate, operating leverage is positive. Of course, the converse produces negative results.

Over the past five quarters, FedEx operating leverage is shown on the table below:

FedEx Operating Leverage – Last 5 Fiscal Quarters

Click to enlarge

Keep an eye on this. It’s another indicator whether FedEx is turning the corner.

Peter Lynch’s PEG Ratio

When evaluating growth stocks, the famous investor and author Peter Lynch advocated the PEG ratio.

FedEx’s three-year forward EPS growth rates is forecast to be 19%, 24%, and 17%, respectively. The first FAST graph in the preceding section provides the detail. Please note, this chart does not reflect the updated FY1Q2024 post-earnings consensus.

I am confident the Street will bump up the earnings growth figures. But for now, let’s use these as-is.

After yesterday’s earnings report, FDX now has a 16x ttm PE:

PE = $262 price / $16.07 ttm operating EPS = 16x

Let’s calculate a PEG2 (two-year) ratio using updated data:

PEG2 = 16 PE / 21% Growth rate = 0.76x

Generally, a PEG under 1.0x is considered to be a good growth stock candidate.

I consider FDX to be no exception: long and strong FedEx common stock.

Valuation

Part of my investment strategy seeks to accumulate stocks that I believe are undervalued, then wait for the Street to recognize it. I do not believe the market is efficient. FDX appears to be a good candidate.

Allow me to illustrate using a few FAST Graphs:

First, here’s a long-term FedEx price-and-earnings chart:

FedEx stock averages ~15x operating earnings multiple [the blue box], which is normal and appropriate. Through the period, the company recorded an 11.5% EPS growth rate.

A 15x P/E is typical for a long-term grower like FDX.

However, let’s take a look at another chart:

Here we have a chart highlighting the period from June 2013 to May 2018. It was a period of solid earnings growth.

Through this particular period, FedEx grew operating earnings by an average ~20 percent a year.

The five-year average P/E was 17x.

This sort of valuation fluctuation is common for industrial cyclical stocks like FedEx. As earnings estimates rise, investors are willing to pay up for future growth. It makes sense that investors may be willing to pay higher earnings multiples for a stock growing 20 percent a year than one growing at 10 percent a year.

Pulling this together, my FedEx stock Fair Value Estimate is $306.

On the September 20 conference call, management guided to $17.00 to $18.50 FY2024 operating EPS. I selected EPS a bit above the midpoint and placed a 17x PE on it based upon the aforementioned discussion.

Current FVE = FY2024 EPS $18.00 x 17 PE = $306

Even after today’s big pop (FedEx was up over 5 percent at one point), that’s still a 17% uplift. The 2 percent annualized dividend adds to the total return.

Note: while FDX is far from a high-yielding stock, good investors know that over the past five years the payout has been increased by an average of 18% a year. FedEx has plenty of free cash flow to cover the dividend.

For reference, my FVE is a dynamic number. I may revise it based upon additional fundamentals, investor conferences, or news releases. By the middle of the fiscal year, I start to look forward to the following fiscal year’s estimates.

Post-earnings, several brokerage houses offered revised price targets:

New targets range from $330 to $205. All reporting revised price targets upward.

Bizarre: explain to me how Morgan Stanley has a “buy” rating on the stock when its analysts forecast a $205 price target! I tend to look at broker price targets in aggregate and do not substitute these for my own FVEs.

Conclusion

Based upon the foregoing discussion, I believe FedEx common stock may be an excellent choice for investors seeking capital appreciation. There is a modest but fast-growing dividend to boot.

The catalyst is new CEO Raj Subramaniam. He is consolidating business units and focusing upon reducing opex and capex intensity. Package volume growth remains sluggish due to macro issues. However, green shoots have become stronger since my last report to you.

Among other indicators, keep an eye upon operating leverage.

FDX valuation is attractive at these levels. Based upon historical performance, forward EPS growth is likely to pave the way for PE multiple expansion. The view is reinforced by the 2-year PEG.

Given the big price surge today (in the face of a dismal overall market), new investors may wish to wait for a pullback.

I look forward to your views and comments below.

Please do your own careful due diligence before making any investment decision. This article is not a recommendation to buy or sell any stock. Good luck with all your 2023 investments.