FedEx: Still Packing Up Profit

FEDEX SHARES HAVE MORE THAN doubled since closing at 34.28 on March 9, handily outpacing the Standard & Poor's 500 Index, as investors poured into cyclical stocks likely to rebound early in an economic upturn.

Although the global economy remains shaky, FedEx (FDX) has upside for the long haul. It has a growing footprint in big overseas markets like China, enough operating leverage to boost earnings when volumes ramp up, and solid growth at its very profitable FedEx Ground unit. In fact, FedEx and its main rival, United Parcel Service (UPS), "are likely to become a global duopoly, and both companies have nearly insurmountable barriers to entry," says Keith Schoonmaker, a senior stock analyst at Morningstar.

The industry's tough dynamics were illustrated when Germany's DHL pulled out of the U.S. domestic package-delivery business in January. But there are stirrings of an economic recovery, as evidenced by FedEx's projection that on Dec. 14, which it expects to be its busiest day in 2009, it will transport more than 13 million packages -- compared with 12 million on 2008's peak day. That's a roughly 8% increase in volume. On average, it ships more than 7.5 million packages daily.

When the economy recovers, "FedEx will be in an even better position than it has been in the past," says Rob Pickels, a senior analyst at asset manager Manning & Napier, which owns FedEx shares. He estimates that the company, which had profit of $3.67 a share for its most recent fiscal year, can earn $7 to $9 in a more normal economy. "Maybe it takes a while for demand to get back to prior levels," Pickels adds, "but FedEx is leaner and will have more market share and more earnings power in the next upcycle." FedEx made $6.67 a share for its fiscal year ended May 2007, before the economy tanked.

Launched in 1971, the company has evolved from a speedy-delivery organization into a multifaceted transportation specialist, having expanded into areas like logistics support. FedEx can bundle a suite of products to customers. Its 65-year-old founder, CEO Frederic Smith, has been in charge for nearly 40 years, and shows no signs of slowing down. "I don't have any plans to go anywhere for the foreseeable future," he says.

FedEx shares have been a good investment over the past 10 years, with a total annual return of 5.7%. That's way ahead of larger rival UPS, whose annual return is minus 0.3%, and the S&P 500, which is at minus 0.9% for the span.

The company's most recent earnings results, which beat expectations, nonetheless illustrate many of its obstacles. An asset-intensive operation, FedEx has budgeted $2.6 billion this fiscal year for capital expenditures, including new aircraft. Its profitability hinges on revenue growth to offset those high fixed costs. For the quarter ended in August, revenue slid to $8 billion, down 20% from a year ago, amid the weak economy and lower fuel surcharges. Net income was 58 cents a share, down from $1.23. Operating margin fell to 3.9%, versus 6.3%.

But FedEx has considerable operating leverage. When revenue does improve, its costs won't grow as quickly, thereby boosting profit. What's more, over the past 18 months, FedEx has slashed costs by about $3 billion; half those cuts are said to be permanent. The reductions have involved, among other things, cuts in base salaries, merit raises and 401(k) matches.

BY FAR THE LARGEST REVENUE producer is FedEx Express, a global-transportation network that reaches more than 220 countries. For fiscal 2009, which ended in May, the Express unit accounted for $22.4 billion, or nearly two-thirds, of total revenue. With its unionized pilots, extensive fleet of aircraft, landing fees and other costs, it is an expensive business to run. Hence its operating margins are typically lower than those of FedEx Ground. However, Express boasts healthy operating leverage, especially internationally. When global trade fully revives, it could get a nice boost.