FedEx Initiated as Neutral - Zacks Tale of the Tape

We are initiating our coverage on FedEx Corp. (FDX) with a Neutral recommendation. The company serves as a proxy for the economy because of the volumes and diversity of the goods shipped.

Though FedEx has suffered from the recession over the last couple of years, improving global economy along with rising trade in international shipping is expected to fuel growth. Management predicts that U.S. industrial production, the main driver of the company’s volume growth, will rise in the mid-single digit range in fiscal 2011, in contrast to declines in each of the past two fiscal years.

With an economic rebound, which will increase demand and volumes, we expect a firming up of pricing. FedEx recently announced a 4.9% increase for ground deliveries and a 5.95% increase for Express shipments. A more stable pricing environment is expected going forward, which will also culminate in improved yields.

FedEx is upbeat about business growth from Asia and Europe. International express packages including those from Asia have margins that are about 35% higher than domestic deliveries. Economic growth prospects in other emerging markets such as India indicate strong volume growth opportunities for the company as well.

However, growth at FedEx, which is dependent on growth in the broader economy, is advancing at a snail’s pace, while housing still remains a problem and unemployment levels stay high. The company’s favorable business results were recently fueled by an increase in its international business, with domestic (U.S.) business contributing very little. Sustainable margin growth is not likely until demand improves. With the economy on a slow recovery path, we expect a pressure on growth in the near term.

FedEx undertook a number of measures to rein in operating costs in 2009. Even with some volume improvement, which is expected in 2010, there could be a delayed effect on margins as the cost reduction initiatives taken earlier begin to unwind. EBIDTA margin contracted to 10.8% in 2009 from 14.7% in 2007.

Moreover, FedEx has reinstated its various employee compensation programs on the back of favorable outlook coupled with an improved quarter. The company had suspended this compensation in fiscal year 2009 as a measure to save costs. The restoration is expected to dampen earnings growth in the reported quarter and fiscal year 2011.

FedEx Freight Services segment is also expected to face a decline in demand for less-than-truckload (LTL) freight services in 2010 as a result of the continued weak economic conditions and excess capacity in the LTL industry. Though the company has recently instituted a price increase, contribution from this segment will not accrue in the near term.

However, the cost containment measures undertaken have poised FedEx to benefit from the turn in the business environment. The company is planning to invest in the fuel efficient Boeing 777 freighter, which will reduce transit time and lead to greater cost and operational efficiencies. Capital spending at FedEx for 2010 is slated at $2.9 billion, up from $2.5 billion in the prior year. These investments will generate significant long term saving and support international business growth.

Also, FedEx continues to generate stable cash flow from operations. As of February 28, 2010, the company had $1.5 billion in cash and cash equivalents on hand, as well as full access to a $1 billion unsecured revolving credit facility. We expect free cash flow to be a little lower in fiscal 2010 than in fiscal 2009 due to a relatively small increase in capital spending, but to remain positive and grow in the upcoming fiscal years with the anticipated growth in overall business.

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