By Ryan Barnes. Edited By Douglas A. McIntyre
FedEx Corp. (FDX) – Price $114.20); Break-up Value $130
FedEx obviously dominates in the international air freight space, and given the high capital costs to operate here and their brand recognition, revenue has some protection on the pricing side. The stock is currently trading at a PEG of just slightly above 1; usually a leading firm like FDX would command a premium, but a combination of economic concerns and rising fuel prices (their largest operating expense outside of employee costs) could be pointed at as culprits to the multiple compression now found in the stock.
Another big factor is that the company has three other segments that it very much does not lead in, including ground transportation, heavy freight, and the FedEx Kinko’s stores, the latter of which has been an operational eye sore since they acquired the chain. The retail stores could be thought of as loss-leaders for the other segments or a glorified ad budget, but our breakup analysis will focus on divesting all three non-core segments in the hopes of allowing FedEx to float to a premium valuation that is deserved based on the high barriers to entry.
FedEx Ground has very similar metrics to UPS in terms of margins and revenue growth, so we can feel safe applying a similar valuation of 1.6x sales, providing a value of just over $9 billion. FedEx LTL Freight (less-than-truckload) has shown decent revenue growth of late, some of which is due to acquisition, but freight is a pretty commoditized business with low margins (currently less than 7%) where FDX doesn’t have the scale to effect pricing if the environment becomes unfavorable. They also have to compete against UPS in this space, and FDX just doesn’t throw off quite enough cash flow to make this an area they can focus resources on. Based on opaque industry levels, this segment should be able to sell for 5-6x operating earnings, or $2.8b.
They will be needing all of their “spare” cash flows to help invigorate the FedEx Kinko’s stores, which we’re actually going to let them keep in our analysis. With current operating margins less than 2%, who else is going to want it? With some effort and a little capital, FedEx could turn this segment around, and a little could go a long way to the bottom line. But in truth the segment is really just a user-friendly way for customers to get express packages into the hands of the company for air shipping, and results could simply be measured against revenue growth at the core business over time.
With the 2 divestitures, FedEx ought to be able to a) solidify their cash position, b) invest in a few more planes just to further enhance their capacity, c) pare down debt, and d)invest in the retail stores, any or all of which should help the PEG get to the 1.4 – 1.5 level worthy of a leading logistics company with a worldwide footprint and the #2 most respected brand in the world (according to Forbes magazine). This would bring the total breakup value to $130/share, a 13% premium to share prices – and with any increased performance at the retail stores becoming grave to earnings estimates in the eyes of analysts and investors.
Ryan Barnes
Ryan Barnes has over 10 years’ experience in portfolio management and investment research, covering equities, fixed income, and derivative products. Ryan spent the past 5 years working as an institutional trader & manager for high-net worth investors, working with Merrill Lynch, Charles Schwab, Morgan Stanley, and many others. Ryan is currently working as a writer and financial modeling consultant on hedging and capital appreciation strategies, and does not own securities in the companies being covered.
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