Fed-Ex Corp. (FDX), the birth mother of the overnight shipping business, and a company that is now a part of American shipping lexicon (“Fed-Ex it, please”) has struggled the last few years, as Express volumes have steadily declined, and the unit has struggled from a profitability perspective. (FedEx Express is 60% of FDX’s total revenues, but just 30% of FDX’s operating income, with an average 6% annual growth in Express operating income over the last 4 years, marked by horrid volatility.)
More importantly, from a cash-flow perspective, FDX is a lot like Intel (INTC), with “capex” (the economic investment required to sustain the economics of the business) ranging from anywhere from 60% to 90% of cash-flow, which is quite a load to carry around if you are a leveraged company. I’ve often referred to companies with a heavy capex load such as this, as the equivalent of marathon runner, trekking uphill, with a piano strapped to their back.
Given the above paragraph, from a free-cash-flow (FCF) perspective, FDX runs a very thin FCF surplus, which is the source of dividends and share repurchase capital.
On October 15th, 2013, when FDX announced a 32 million share repurchase program, the stock jumped from $115 to $122 (closed on 10/15/13 at just over $120) and then proceeded to trade above the March ’07 all-time high for the rest of October.
Here is how I see FDX generating the free-cash-flow to repurchase the 32 million share program. Let’s say shares are repo’ed at an average of $122.50 (and there was no time limit set for when the stock could be repo’ed so it could extend for years), which comes to a total of roughly $4 billion in free-cash-flow. (FDX has a total of 319 ml shares outstanding, so the total repo plan is a 10% reduction in shares outstanding. From our math, the share repo plan on its own is worth an additional $0.50 per share to FDX, but that isn’t the point of this article. )
We attached a portion of our internal spreadsheet which details FDX’s cash-flow in detail. About 3/4th of the way down the spreadsheet, look for the line “4q trailing FCF”, which shows the history of FDX’s free-cash-flow generation.
It isn’t that I don’t think that FDX will repurchase the shares, I simply wonder how long it will take the company to do so, given the historical free-cash-flow, and is the $15 pop in the stock price justified ? The most FCF FDX ever generated was $1.8 bl in August ’13, and then also $1.8 bl in August, 2004 (not shown).
There is no question FDX is in the throes of an important business transition today as Express shrinks, the Ground business continues to perform well, and Freight is trying to recover. The other drag on FDX’s business is the US economy: the FDX model is built on volume growth over a sizable fixed-cost base, so the faster the better. When volume sputters and lags, profits do the same.
FDX is trying to boost their free-cash-flow through the retiring of employees who accepted buyouts and the downsizing of FDX’s work force. Downsizing has already contracted the the company’s pension liability as detailed on the balance sheet. Just in the last 5 quarters, here is FDX’s pension and post-retirement healthcare liabilities:
8/13 q1: $3.8 billion
5/13 Q4: $3.9 billion
2/13 q3: $5.36 billion
11/12 q2: $5.45 billion
8/12 q1: $5.5 billion
Some of this decline could be a function of a strong equity market and rising rates, but you would have to think that the reduction in the liability is primarily driven by workforce reduction.
Eventually this reduction will help free-cash-flow as will a reduction in capex, which you can also see on the spreadsheet has started to fall sharply the last two quarters.
The point of this article being then, that what looks to be a continued reduction in pension expense via headcount reductions, and if not lower capex growth, then actual capex shrinkage, could provide the bulk of the free-cash-flow to repurchase the shares. Shrinking capex isn’t necessarily a positive since it is basically management’s way of saying there are fewer long-term investment opportunities, and we are just going to return this cash to shareholders.
FDX broke out to an all-time high in October ’13, trading above its March ’07 high. The recent share repurchase plan was a bit of a surprise given the dearth of FCF but it looks like they are improving free-cash from the above-named sources.
Morningstar puts an intrinsic value on FDX of $122 per share. Our internal model puts an intrinsic value on FDX of $140 as of the August ’13 quarter, and EPS estimates continue to rise, probably based on the drop in crude oil, and the stronger ISM data here in the US.
FDX is fairly valued today given the metrics, but respect the technical breakout to an all-time high. I can see how FDX gets to the $4 billion share repo plan, but it will take some time, and it looks like a tight squeeze.
The stock would benefit further from three macro events:
1.) Continued decline in the price of jet fuel;
2.) Continued economic recoveries in China, Europe and SouthEast Asia, with customer’s gravitating back to the Express business;
3.) Stronger volumes, driven by #2;
For investors like ourselves who like to get into the cash-flow detail, I needed to know how FDX got to $4 billion in free-cash-flow. That number seemed unthinkable a year ago.
Perhaps a better title should have been, “Is Fed-Ex now a 3% – 4% secular grower and the latest cash cow ?”
Thanks for reading,
Trinity Asset Management, Inc. by:
Brian Gilmartin, CFA
Portfolio manager