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Elevator Pitch
I rate FedEx Corporation (NYSE:FDX) as a Hold.
At first glance, FDX seems like a Buy after delivering largely in-line (a -0.1% difference between actual and consensus EPS) earnings for Q4 FY 2022 (YE May 31) and better-than-expected FY 2023 guidance. But my view is that FedEx’s profitability expectations implied by its short-term and medium-term financial goals are too demanding, and weaker-than-expected e-commerce growth going forward might make it tough for the company to maintain its current pricing and yields.
More importantly, I see FDX’s shares as being fairly valued, which warrants a Hold investment rating. FedEx’s 10.2 times forward P/E is undemanding on an absolute basis and lower on a relative basis with respect to historical averages. Although FDX’s forward free cash flow yield of 6.1% is less appealing, FedEx doesn’t deserve a Sell rating either.
Did FedEx Beat Earnings?
FedEx issued the company’s Q4 FY 2022 financial results press release on June 23, 2022 after the market closed.
The company’s recent quarterly earnings didn’t beat the market’s expectations. FDX’s fourth-quarter adjusted non-GAAP earnings per share or EPS of $6.87 came in marginally ($0.01) below Wall Street’s consensus EPS estimate of $6.88.
FDX Stock Key Metrics
Notwithstanding the marginal bottom line miss for the fourth quarter of fiscal 2022, FDX’s stock price initially rose by +7% from $228.13 as of June 23, 2022 to $243.24 as of June 24. However, FedEx’s shares pulled back by -4% in the subsequent three trading days to close at $233.81 as of June 29.
An analysis of FedEx’s key metrics for Q4 FY 2022 will shed light on the market’s reaction to FDX’s marginal EPS miss. In a nutshell, this has been a mixed quarter for FDX, with the better-than-expected performance for the Freight segment negated by weaker-than-expected results for the Ground segment.
The Freight segment saw its revenue and operating profit increase by +23% YoY and +67% YoY to $2,756 million and $602 million, respectively in the recent quarter. The Q4 FY 2022 operating income for FDX’s Freight segment turned out to be +31% higher than the sell-side’s consensus projection of $460 million as per S&P Capital IQ. The outperformance was driven by a +28% YoY increase in yield per shipment and a new historical high quarterly Freight segment operating margin of 21.8%.
At the company’s Q4 FY 2022 investor call on June 23, 2022, FDX noted that “the freight LTL (Less-Than-Truckload) business (industry) has certainly evolved from where it was a number of years ago” with greater “price discipline” and a more moderate pace of “capacity adds (additions)”, which has been positive for the company’s Freight segment.
On the flip side, revenue for FedEx’s Ground segment increased by +4% YoY to $8,491 million in Q4 FY 2022, but this was -3% below the market’s consensus top line forecast according to S&P Capital IQ data. More significantly, the Ground segment’s operating income of $849 million fell short of the sell-side’s consensus operating profit projection of $1,012 million by -16%.
The company attributed the weak performance of the Ground segment to “yield management actions affecting our FedEx Ground economy service” with a -36% YoY drop in “FedEx Ground economy volumes” at its Q4 FY 2022 earnings briefing. But FDX also acknowledged at its recent quarterly earnings call that “slower customer demand” had a negative impact on the volume growth for its Ground segment.
In conclusion, it is hardly surprising that FedEx’s stock price has increased by just +3% in the week after its Q4 FY 2022 results announcement. FDX’s bottom line was a slight miss, and there is a huge divergence in the performance of the company’s Freight and Ground segments in the recent quarter.
What Is FedEx’s Forecast?
Looking forward, both FedEx’s short-term and intermediate-term financial forecasts are worth paying attention to.
FDX guided for an EPS of $23.50 (mid-point of guidance) for fiscal 2023 as it announced its Q4 FY 2022 financial results. This is equivalent to a +14% growth as compared to FedEx’s FY 2022 adjusted non-GAAP EPS of $20.61. Moreover, the expected FY 2023 EPS of $23.50 was +6% better than what analysts had forecasted, according to data sourced from S&P Capital IQ.
Notably, FedEx pointed out at its Q4 FY 2022 results call that “margin expansion in all of our transportation segments” was a key assumption supporting the company’s FY 2023 guidance.
Separately, FDX also outlined its medium-term expectations in the company’s Investor Day press release published on June 29, 2022, where it guided for a “compound annual growth rate for adjusted EPS of 14–19% through fiscal 2025.”
FedEx expects a +4%-6% revenue CAGR and an expansion in its overall operating profit margin from 7.3% in FY 2022 to 10% in FY 2025 will help the company to achieve its intermediate-term bottom line growth target.
In summary, the improvement in profitability holds the key to FDX’s ability to deliver on the company’s short-term and medium-term goals.
Is FedEx Profitable?
FedEx has been profitable in every year for the past three decades since FY 1993 based on S&P Capital IQ data. The company is also expected to stay profitable between FY 2023 and FY 2027 according to the sell-side’s consensus estimates. As such, investors are focused more on how profitable (level of profit margins) FedEx can be, rather than whether it will remain profitable going forward.
As discussed in the preceding section, a significant increase in the company’s operating margin is needed to allow FedEx to achieve a mid-to-high teens EPS CAGR for the intermediate term.
Specifically, the company’s Ground segment, which was the weak spot for FDX in Q4 FY 2022, has the greatest potential for profitability improvement. FedEx is targeting an operating margin in the 11%-12% range for the Ground segment in FY 2025, as compared to a 8% operating margin registered in FY 2022. At FedEx’s 2022 Investor Day presentation held on June 29, 2022, FDX revealed that the margins for the Ground segment will increase by “focusing on profitable revenue through targeted growth” and a goal of delivering “$1 billion in cost savings through productivity initiatives.”
In my opinion, it will be challenging for FDX to deliver the margin improvement it guided for. In a post-pandemic environment with worries about a potential recession, it is likely that consumers will spend more money on services (as opposed to physical goods) or even cut back on overall spending, which implies that a sharp slowdown in e-commerce growth is inevitable. This would suggest that FedEx could struggle to sustain its strong pricing and high yields. As such, FDX’s actual earnings and profit margins in the future might fall short of expectations. In other words, FedEx might be less profitable than what it expects.
Is FDX Stock Overvalued Now?
FDX stock is fairly valued rather than overvalued in my view, despite outperforming the S&P 500 in 2022 year-to-date.
So far this year, FDX’s stock price has declined by -9.6% as compared to a -19.8% drop for the S&P 500 during this period. But it will be a stretch to label FedEx’s shares as overvalued.
On the surface, FedEx’s shares appear to be cheap. The market currently values FDX at 10.2 times (implied 9.8% earnings yield) consensus forward next twelve months’ normalized P/E as per S&P Capital IQ, which is also substantially below its five-year mean P/E multiple of 13.6 times.
On the other hand, FDX currently trades at a relatively higher 16.1 times consensus forward next twelve months’ price to free cash flow or forward free cash flow yield of 6.1%, based on S&P Capital IQ’s valuation data.
The difference in FDX’s forward earnings yield and free cash flow yield is a reflection of the adjustments made to the company’s non-GAAP earnings (as opposed to GAAP profit) and explains the divergence in FedEx’s non-GAAP income and free cash flow.
In conclusion, I think that FedEx’s shares are at a fair valuation now, considering both earnings- and free cash flow-based valuation metrics.
Is FDX Stock A Buy, Sell, or Hold?
FDX stock is a Hold. Taking into account the company’s profitability outlook and its valuations, I have a Neutral view for FedEx. FedEx has a very good track record of past profitability, but it is less likely to deliver the margin improvements it expects. Separately. FDX’s overall valuations are neither cheap nor expensive, considering both forward P/E and free cash flow yield valuation metrics.
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