August 26, 2016

Markets Look At FedEx With Too Much Optimism


Summary

  • FedEx is expected to see improving Adjusted ROA (ROA’) levels, but management’s concerns about the sustainability of increases in revenues, margins, and EPS indicate that this may be unwarranted.
  • FDX is trading at a 1.2x Adjusted Value to Assets Ratio (V/A’), near historical averages.
  • At these levels, the market is pricing in expectations for substantial expansion in ROA’ levels and continued Adjusted Asset (Asset’) growth.
  • FedEx’s poor historical profitability, as well as management’s concerns about the sustainability of increases in revenues and cash flows, imply that market expectations may be too bullish.

FDX

FDX has seen historically cyclical ROA’ performance, increasing from 3.3% in 2001 to a peak of 6.1% in 2007. However, ROA’ declined to a mere 0.7% in 2009, and has recovered slowly, to just 4.6% in 2015. Meanwhile, Asset’ growth had been consistently positive prior to 2009, ranging from 3%-11% levels. Afterwards, growth slowed in 2009-2010 to negative levels, before rebounding to 7.7% in 2011, and ranging from 1%-8% levels since.

Performance Drivers – Sales, Margins, and Turns

It can be helpful to break down ROA’ into its DuPont formula parts, Earnings’ Margin and Asset’ Turns, which are the cleaned up margins and turns metrics used to calculate ROA’. The chart below details both Earnings’ Margin and Asset’ Turns historically, to help us better understand the drivers of the firm’s profitability and performance.

FDX 1

Valuation Matrix – ROA’ and Asset’ Growth as Drivers of Valuation

When valuing a company, it is important to consider more than a singular target price, and instead the potential value of a firm at various levels of performance. The below matrix highlights potential prices for FDX at various levels of profitability (in terms of ROA’) and growth (Asset’ growth.) Prices that are in excess of 10% equity upside are highlighted in black, and prices representing an excess of 10% equity downside are highlighted in red.

FDX 2



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