FedEx makes big bets on aircraft

The company has placed large orders for new planes, which will cut travel times but eat into cash flow.

By Kim Peterson Nov 17, 2010 2:41PM
Credit: © PAUL J. RICHARDS/AFP/Getty Images)
Caption: Federal Express cargo jetsIf you're a FedEx (FDX) investor, you're paying close attention to the company's workhorse: the cargo plane.

FedEx is making a huge investment in its fleet with new Boeing 777s, which is taking a bite out of the company's bottom line in the short term. But down the road, these new planes will give the company a smart edge.

The company has eight 777s in service and 32 on the way. And that brings good and bad news for investors, according to analysts at UBS, which recently spent three days hosting representatives from the company.

First the good: The new planes have 5% more capacity and are 18% more fuel-efficient than the MD-11s previously used, the analysts wrote in a report out Wednesday.

The 777s cut down on travel time as well, making FedEx faster than rival UPS (UPS) by two hours from Asia to the U.S. and one day from Asia to Europe. Long term, that's going to be a nice advantage. Post continues after video:
The planes have enabled FedEx to expand routes and establish new ones. FedEx Express is adding a second 777 route in China from Shenzhen, with four flights a week. The company already flies 777s out of Shanghai.

FedEx has also assigned a new 777 to fly from Hong Kong to Indianapolis, making that city "one of the few major air hubs fanning Chinese goods across America," the Indianapolis Star reports.

But here's the bad news: Those planes cost big money. FedEx has a $3.5 billion capital budget for new 777s this year alone, its chief executive told The New York Times.

Capital spending as a percentage of sales has jumped from 7% in the 2009 fiscal year to about 9% this year and next, the UBS analysts say. That pushes out material gains in free cash flow to at least 2013.

"While poor returns scare some investors away, the reality as we see it is that FDX remains purely an operating leverage/EPS growth story, but arguably the best in the U.S. transportation sector," the analysts write.

FedEx had threatened to cancel orders for up to 30 777s if a proposal went through to put FedEx Express under the jurisdiction of the National Labor Relations Act. That would have made it easier for FedEx employees to organize into local bargaining units.

But that's pretty much a dead issue now, since one of the few members of Congress pushing it lost his House seat in the November elections.

The UBS analysts kept their buy rating on the stock and upped their 12-month price target by $6 to $111. FedEx shares are flat Wednesday, trading in the afternoon at $85.92.

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