Look past FedEx's holiday problems to its 20% upside

This company's aggressive growth strategy and international exposure could mean big profits for patient investors.

By StreetAuthority Jan 21, 2014 3:36PM
FedEx boxes on a delivery truck in New York City (© Mike Segar/Newscom/Reuters)By Marshall Hargrave                                                                         

There's nothing like not getting your package delivered in time for Christmas.

This happened to a number of consumers this holiday season. The online retailers blamed the major shipping companies. The shipping companies blamed the online retailers. Customers were outraged. They took to social media, calling out both online retailers and the major delivery companies.

Surprisingly, the market stood by the shipping stocks and none took a major hit on the negative news. Investors should take this as a sign of confidence. FedEx (FDX) was one of the companies at the center of the ruined package delivery debacle, but investors shouldn't let their holiday mishaps interfere with their investing.

Gearing up for 2014
The short Thanksgiving-to-Christmas timeframe and an overwhelming number of e-commerce purchases showed just how unprepared the major shippers were. FedEx has been throwing money into its infrastructure and will be more than prepared for the steady rise in e-commerce next holiday season. FedEx will have three to five new hubs available for ground delivery next holiday season.

The fact remains that as retailers battle for customers, the one sure winner will be shippers like FedEx.

In the eyes of the consumer, the blame is being directed more toward the online retailers rather than the shipping companies. After all, their purchases were with the online retailers and not with FedEx or UPS (UPS).

In the effort to modernize its air fleet, FedEx retired almost 90 aircraft last year. By the end of 2016, FedEx expects to boost its incremental FedEx Express profit by over $1.5 billion and improve its fleetwide fuel efficiency by 30 percent.

In terms of the shipping companies, FedEx performed better than UPS, which claimed that the volume of air packages in its system exceeded capacity because demand was much greater than it had forecast. FedEx was also affected, but not to the extent that UPS was -- FedEx delays were more due to weather than anything else.

Infrastructure spending and international expansion 
As mentioned, FedEx continues to pump its cash flow back into the company in the form of capital expenditures. FedEx's capital spending as a percentage of sales is double that of UPS.

Part of these capital expenditures are going toward deploying more fuel-efficient aircraft. In the effort to modernize its air fleet, the company retired almost 90 aircraft last year. The other part of capital expenditures is going toward increasing its FedEx Express profit. By the end of 2016, FedEx expects to boost its incremental FedEx Express profit by over $1.5 billion and improve its fleetwide fuel efficiency by 30 percent.

International markets remain one of the big growth stories for FedEx. The company has been expanding in Asia and Latin America, both of which should see a rising level of shipments as their economies urbanize. As part of this initiative, FedEx is building a new hub in China that will serve over a hundred Chinese cities.

In the U.S., FedEx managed to extend its contract with the U.S. Postal Service in a seven-year deal worth more than $10 billion. This was a huge win for FedEx over UPS. All in all, FedEx is looking to drive its earnings growth with its efficiency improvements and by tapping international markets.

Some big names have bought shares of FedEx recently. Billionaires George Soros, John Paulson and Dan Loeb are all shareholders. But they don't have quite the stake of FedEx's chairman and CEO, Fred Smith, who owns 6 percent of the company.

The other big buyer of FedEx stock is FedEx itself. The company just issued $2 billion in debt to accelerate its share repurchase program. FedEx will immediately repurchase 11.4 million shares after the debt sale is complete.

Risks to consider: FedEx still has a lot of exposure to Europe and emerging markets, both of which have proved to be volatile. As well, FedEx is exposed to the broader economy, so any delay in the recovery could impede FedEx's positive performance.

Action to take: FedEx is cheaper than UPS across the board -- but FedEx definitely deserves a higher valuation, given its stronghold on the market. A price-to-earnings (P/E) multiple of 19 on 2015 earnings of $8.91 a share suggests the stock should be trading at $170 in just over a year, which is more than 20 percent upside.

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