FEDEX Stock & Performance Analysis Report

FIN 6350 ADVANCED FINANCIAL MANAGEMENT Term Project

Group Members:
Doug Effler Firozkhan Pathan Sadak Shaik Syed Raza Terry Beck

FIN 6350 Advanced Financial Management Term Project

Table of Contents
SECTION 1: OVERVIEW OF RESULTS, RECOMMENDATION AND REASONS ......................................................... 2 SECTION 2: COMPANY INTRODUCTION, PRODUCTS AND COMPETITORS .......................................................... 3 Company Introduction: .................................................................................................................................... 3 Sector and Industry:......................................................................................................................................... 3 Competitors: .................................................................................................................................................... 3 SECTION 3: CURRENT FINANCIAL PERFORMANCE .............................................................................................. 4 Liquidity ratios: ................................................................................................................................................ 4 Asset management ratios: ............................................................................................................................... 4 Debt management ratios: ................................................................................................................................ 4 Profitability Ratios: .......................................................................................................................................... 4 Market value ratios:......................................................................................................................................... 4 Du Pont Analysis: ............................................................................................................................................. 5 SECTION 4: FUTURE REVENUES FORECAST ......................................................................................................... 6 Sales Forecast: ..................................................................................................................................................... 6 SECTION 5: FORECASTED FUTURE PERFORMANCE AND FINANCIAL STATEMENTS ............................................ 8 Income Statement: .......................................................................................................................................... 8 Balance Sheet: ................................................................................................................................................. 8 Statement of Cash Flow: .................................................................................................................................. 8 SECTION 6: COST OF CAPITAL ............................................................................................................................ 10 Cost of Equity (re): .......................................................................................................................................... 10 Cost of Debt (rd): ............................................................................................................................................ 11 Weighted Average Cost of Capital (WACC): .................................................................................................. 11 SECTION 7: STOCK VALUATION.......................................................................................................................... 12 Estimated value of operations and price per share:...................................................................................... 12 Scenario Analysis: .......................................................................................................................................... 12 SECTION 8: RECOMMENDATIONS ..................................................................................................................... 13 REFERENCES ....................................................................................................................................................... 14

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SECTION 1: OVERVIEW OF RESULTS, RECOMMENDATION AND REASONS

Our analysis of the FedEx valuation and sale forecast with the signs of improvement in the global economy and growth in emerging markets lead us to issue a STONG BUY recommendation. Our sales growth projections are more conservative than S&P analysis and are tempered by macroeconomic factors that may adversely affect FedEx operations. The freight and shipping industry is very sensitive to fuel costs, and analysts estimate that each one cent increase in the cost of a gallon of jet fuel would decrease FedEx quarterly earnings by one cent per share. Although the company plans to use a fuel surcharge strategy to mitigate this issue, investors should be mindful that geopolitical risks in oil producing countries may be of some consequences to FedEx financial performance. We dont see it as a major issue in near terms but investors should monitor the regulatory environment for possible changes in legislation regarding imposition of sales tax on online purchases. In most states, online purchases are not currently taxed, but some states have expressed interest in collecting sales taxes from online retailers in order to reduce their budget deficits. Such changes would make online retailers less competitive compared to brick-and-mortar stores, which would have negative repercussions on FedExs sales. We believe that FedEx can mitigate those risks by its efficient operational capabilities and economy of scale.

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SECTION 2: COMPANY INTRODUCTION, PRODUCTS AND COMPETITORS

Company Introduction:
FedEx Corporation (FedEx), incorporated on October 2, 1997, is a holding company. The Company provides a portfolio of transportation, e-commerce and business services under global FedEx brand. The Company operates in four segments: FedEx Express, FedEx Ground, FedEx Freight and FedEx Services. Federal Express Corporation (FedEx Express) is an express transportation company; it offers time-sensitive delivery within one to three business days. FedEx Ground Package System, Inc. (FedEx Ground) is a provider of small-package ground delivery service. FedEx Ground provides low cost service to every business address in the United States and Canada. FedEx Freight Corporation is a provider of less-than-truckload (LTL) freight services through its FedEx Freight business and its FedEx National LTL business. FedEx Corporate Services, Inc. (FedEx Services) provides its other companies with sales, marketing and information technology support, as well as customer service support through FedEx Customer Information Services, Inc. The largest subsidiary of FedEx (about 60% of sales), FedEx Express is responsible for its parent's namesake express delivery business, the world's largest. FedEx Express delivers 3.5 million packages per day throughout the US and to some 220 countries and territories worldwide. The company operates a fleet of approximately 665 aircraft and 41,000 motor vehicles and trailers.

Sector and Industry:

The company belongs to Couriers (NAICS 492110) industry which comprises establishments primarily engaged in providing air, surface, or combined courier delivery services of parcels generally between metropolitan areas or urban centers. The establishments of this industry form a network including courier local pickup and delivery to serve their customers' needs. The company belongs to air freight sector which grew by 22.8% in 2010 to reach a value of $103.2 billion.

Competitors:
The Company competes with United Parcel Service, Inc., DHL, TNT, Con-Way Freight, YRC Regional Transportation, UPS Freight and the U.S. Postal Service. The express package and freight markets are both highly competitive and sensitive to price and service. The ability to compete effectively depends upon price, frequency and capacity of scheduled service, ability to track packages, extent of geographic coverage, reliability and innovative service offerings. FedExs principal competitors in the international market are DHL, UPS, foreign postal authorities such as Deutsche Post and TNT N.V., freight forwarders, passenger airlines and all-cargo airlines. Many of FedEx Expresss competitors in the international market are government-owned, -controlled or subsidized carriers, which may have greater resources, lower costs, less profit sensitivity and more favorable operating conditions than FedEx Express. FedEx ranks world 5th in Air Cargo Services, as well as in Logistics Services, in Postal Services, in Specialty Trucking, in Supply Chain Management Services, and in Truckload Carriers, behind US Postal Service, UPS, Deutsche Post, and Japan Post. FedEx is 3rd in Less Than Truckload Carriers behind ABF Freight System and Averitt Express.

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SECTION 3: CURRENT FINANCIAL PERFORMANCE

The data to calculate current and historical financial ratios of FedEx was obtained from the companys annual reports of year 2009 and 2010. The industry and competitor (UPS) financial ratios were obtained from Mergent Online database. Please see table 1.9 for ratio calculation details.

Liquidity ratios:
Liquidity ratios are a class of financial metrics that is used to determine a company's ability to pay off its short-terms debts obligations. Generally, the higher the value of the ratio means the larger the margin of safety that the company possesses to cover any short-term debts. For the latest year 2010, both current ratio (1.57) and quick ratio (1.48) are better than industry average (1.48 and 0.98) but they are still lower if compared to UPS (1.96 and 1.56).

Asset management ratios:

Asset Management Ratios attempt to measure the firm's success in managing its assets to generate sales. Inventory turnover (89.29) is very high compared to industry (38.36); still it has gone down in 2010 compared to 2009 (96.72). Similarly Asset turnover ratios also have gone down in 2010 compared to 2009. DSO also increased in 2010 (43.75) compared to 2009 (34.87).

Debt management ratios:

Debt Management Ratios attempt to measure the firm's use of Financial Leverage and ability to avoid financial distress in the long run. Debt ratio has increased in 2010 (44.54%) over 2009 (43.8%) but it is still on par with industry average (44.12%). The times-interest-earned or interest coverage ratio has increased more than twice in 2010 (27.68) compared to 2009 (12.47). The new 2010 interest coverage ratio is much higher than competitor UPS (16.59).

Profitability Ratios:
Profitability ratios are a class of financial metrics that are used to assess a business's ability to generate earnings as compared to its expenses and other relevant costs incurred during a specific period of time. The profit margin in 2010 increased to 3.41% compared to just 0.28% of 2009, which is a good sign. But it is still less than half of its competitor UPS which has profit margin of 7.04%. Similar is the case with other profitability ratios.

Market value ratios:

Market Value Ratios relate an observable market value, the stock price, to book values obtained from the firm's financial statements. The P/E ratio of 21.63 is marginally better than competitor UPS with P/E ratio of 21.05. This shows good investor confidence in FedEx stock. The diluted EPS of $3.76 is also relatively healthy compared to competitor UPS with diluted EPS of $3.48.

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Du Pont Analysis:
DuPont analysis examines how a business's ROE is affected by three factors: 1) Operating efficiency, which is measured by profit margin 2) Asset use efficiency, which is measured by total asset turnover 3) Financial leverage, which is measured by the equity multiplier. Du Pont analysis ROE = 2009 2010 ROE = ROE = Profit Margin x Asset Turnover x 0.276% 3.41% 1.464 1.39 Equity Multiplier 1.779 1.78 = 0.72% 8.46%

The ROE increased almost twelve times in 2010 from the previous year. The source of the huge increase in ROE for year 2010 compared to 2009 can be easily identified as resulting from the increase in profit margin. The equity multiplier remained almost constant between the two years, while asset turnover was slightly lower compared to 2009.

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SECTION 4: FUTURE REVENUES FORECAST Sales Forecast:

According to data from the U.S. Board of Transport Statistics, in 2010, total cargo (measured in revenue ton-miles) rose 18.8% to 58.6 billion, with international up 24.4%, and domestic up 5.7%. In 2009, total cargo fell 13.5%, with international down 15% and domestic down 13%. In 2008, total cargo fell 6.9% to 37.1 billion, with international volumes down 5.2% and domestic down 9.0%. We are seeing signs of recovery from the global recession. In 2010, the S&P Air Freight and Logistics Index gained 25.8%, versus a 14.2% rise for the S&P 1500. Based on these trends we believe an improving U.S. and global economy is likely to lead to increased volumes across FEDEX's entire network, and improved capacity utilization should drive margin expansion in FY 11 and beyond. We believe the volume of activity coming out of Asia, and particularly China will increase air freight volumes over the next the few years. Air Freight companies UPS and FedEx are both increasing their presence in these markets by adding facilities and flights to and from Asia. Domestic volume improvement also signals that the economic recovery is starting to gain traction and we anticipate FedEx Ground will likely benefit from the exit of DHL from the U.S. business. We believe that FEDEX is the strongest performer in the industry and offers total logistics and information services to their customers. It has recently added fuel efficient Boeing 777s and is an early adopter of electric, hybrid and fuel efficient vehicles. Their 30/30 strategic plan is to increase overall fuel efficiency by 30% by 2030. We think they are best positioned to capitalize on the strengthening demand we foresee, and we believe they will be able to offset higher fuel costs with rate increases and/or fuel surcharges. FEDEX doesnt hedge the fuel cost, rather it passes the price hike to the customer by fuel surcharge. FEDEX revenues increased at a compound annual growth rate (CAGR) of 5.87%, 1.47% and -4.33% in the last 10, 5, and 2 years respectively. The Average annual growth rate was 6.85%, 3.64% and -4.31% in the last 10, 5 and 2 years respectively. Please see table 1.6 for details. The regression analysis based forecast is: Revenue (2011) max = $45,876.75M (32.08% annual growth) and Revenue (2011) min = $36,084.05M (3.89% annual growth) Analysts estimate revenue growth to range from 8.40% - 14%. Based on the analysts estimates and regression analysis, we take the relatively conservative approach of revenue growth in the FY11 of 10%. We assume that the expansion and high growth in Asia with the improvement in the domestic economic conditions will increase the revenue growth. We forecast revenue growth to be 11%, 11.5% and 12% for FY12, FY13 and FY14 respectively. Risks to our recommendation and target price include a possible price war on excess capacity. The company would likely incur higher labor costs if challenges to the companys independent contractor model are successful, or attempts to overturn the U.S. Railway Labor Act succeed. FedEx recently announced a plan to combine and restructure its two freight operations, which it expects to lead to one-time charges of $0.28-$0.34 a share in FY 11. In addition, FedEx
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faces pension cost headwinds and rising maintenance costs to bring idled planes back into service. Reinstatement of bonuses and 401(k) matching should lead to higher compensation expense.

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SECTION 5: FORECASTED FUTURE PERFORMANCE AND FINANCIAL STATEMENTS

Income Statement:
The forecasted income statement is based primarily on the steady growth indicated in the percentage-of-sales spreadsheet (table 1.3) and the sales forecasts determined by team research into company documents and external analysts. There are two notable exceptions. The interest expenses in the FEDEX 2010 annual report do not appear to be a function of debt and represent a much lower interest rate than appears reasonable. Therefore, we have fixed interest expense at $71 million in all forecasted years, as highlighted on the income statement. Second, as noted previously in this report, the company anticipates a one-time restructuring charge in 2011 amounting to $.28 to $.34 per share. We have anticipated this cost at the higher end and have included this charge for 2011 and subsequently forecasted no charges in this area. Please see table 1.7 for details Receivables, inventories, payables and accruals levels are based on trailing five year averages (table 1.1). Fuel costs are also based upon the 5 year average and this reflects, first, the tremendous uncertainty in this area, as well as FEDEXs intention to use fuel surcharges on deliveries should fuel prices range outside anticipated corridors. The indicated depreciation level anticipates the company will maintain net PP&E at approximately 41% of revenues. Based upon the companys announced intention to purchase new aircraft offering greater fuel efficiency this appears reasonable. Dividend levels are forecasted to increase in line with overall revenue growth with no new equity offerings anticipated. The companys overall tax rate is constant at 37.5%.

Balance Sheet:
We expect the companys intangible assets to lose some of their value over time and this offsets to some extent our slight increase in PP&E as a percent of total assets. As stated previously this reflects fleet modernization. Current asset and liabilities levels are maintained as an average percent of sales back-checked with the common-size-balance-sheet (table 1.2). Current debt levels are based on the 2010 annual report; likewise the L-T debt levels are based on the AR and reflect no further debt issuance in the forecasted period. The 2011 restructuring charge is reflected, as well as the impact of the admittedly unreasonable interest costs. We have used short-term investments to maintain balance and these levels decrease in the later years of the forecast. We discussed using this excess liquidity to increase the level of treasury stock but, based on a various short-term uncertainties, we decided against it. We have based pension costs as a fixed percentage of sales. This may or may not be reasonable, but our research did not allow any conclusions in this area. Please see table 1.7 for details.

Statement of Cash Flows:

The statement of cash flows obviously reflects the BS and IS and shows growth in operating cash flows in line with the revenue growth. Dividend expense grows linearly and our AFN calculations indicate no need for further debt issuance. L-T debt reflects AR actual. We have

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assumed a constant expense related to adverse exchange rate fluctuation based on 2008 and 2010 data, but admittedly this is an estimate. Please see table 1.8 for details.

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SECTION 6: COST OF CAPITAL

FedExs cost of capital is evaluated as a weighted average of its cost of equity and cost of debt. FedEx has currently no preferred stock in their balance sheet. Since the bond maturities also differ substantially, we split it into two parts: mid-range debt yields and long-term debt yields. The components of WACC we have used are: Cost of Equity Cost of Mid-term Debt Cost of Long-term Debt

Please see table 1.5 for details.

Cost of Equity (re):

The cost of equity is the minimum rate of return firm must offer its shareholders to compensate for risk and time factors related to their returns. We calculated cost of equity using the Capital Asset Pricing Model (CAPM). re = rf + [e(rm - rf)] We used the risk free rate (rf) of 3.35%, as of 3/14/2011 and historical market risk premium (rm-rf) of 5.10%. We note that FedEx acquired Kinkos and Parcel Direct in 2004. The company structure changed significantly as a result of these acquisitions; therefore we do not used historical data beyond 2005, since using data from or prior to 2004 would include irrelevant information. We calculated beta using regression, using monthly stock prices of FEDEX for last five years against benchmark S&P for the same period of time. For our calculation of WACC, we averaged the beta we got using regression and beta we got from Yahoo which is 1.22. Using CAPM, we got cost of equity of 9.56%.

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Cost of Debt (rd):

Since the maturities differ substantially, we felt it best split non-current debt into two parts: mid-range debt yields and long-term debt yields (adding an extra term in the WACC) MaturityDate 2011 2013 2014 2019 2098 Total: Amount (in millions) 250 300 250 750 239 1789 Interest Rate 7.25% 9.65% 7.38% 8.00% 7.60%

Based upon this information, we calculate FedExs mid range cost of debt (rdm) as: rdm = (250 x .0725) + (300 x .0965) + (250 x .0738) + (750 x .08) 1550 8.10% The long term debt yield is rdl = 7.60%

rdm =

Weighted Average Cost of Capital (WACC):

In their 2010 annual report, FedEx indicates the company has 314 million shares outstanding and debt of $1,789 million ($239 million is very long term while $1550 million as mid range). As of March 14, 2011, the share price was $88.63. Market cap is therefore 314(88.63) = $27,830 million. As noted above, we use two components for debt: mid-range and long term debt. Using the following formula we calculate the WACC.
( ) ( )

WACC = 9.45%

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SECTION 7: STOCK VALUATION

Estimated value of operations and price per share:
We projected the financial statements for the next four years (2011 to 2014) using the percentage of sales method (see table 1.3). We calculated the value of the operations and the stock price for FedEx using the Free Cash Flow (FCF) method utilizing the projected financial statements. Please see table 1.8 for details. We calculated the Horizon Value (HV) of FedEx at the end of 2014 based on the assumption that the FCF will grow at a constant rate of 4% after 2014. We evaluated the WACC for FedEx using the three components (cost of equity, mid-term debt & long-term debt). We then calculated the value of operations for FedEx by discounting the FCF for 2011 to 2014 and the HV at 2014 using the WACC of 9.45%. This resulted in the value of operations to be $44,912 (in millions). Now, deducting the value of the debt of $1,789 (in millions) from the value of operations gives us the intrinsic value of equity of FedEx at $41,623 (in millions). By dividing the value of equity with the total number of outstanding FedEx common shares (314 million) we estimate share price of FedEx at $132.56.

Scenario Analysis:
The valuation of the company is dependent on various factors like volatility in fuel prices, the state of the overall economy (GDP) and the execution of operations within FedEx. The above factors can be captured by two variables in our valuation: growth rate and WACC. We used these two variables to perform a scenario analysis using Excels What-if analysis feature. Based on our own research using regression analysis and the analyst forecasts for the growth rate, we used a growth rate of 8%-13% and similarly WACC of 8%-11% for the purposes of our scenario analysis. Please see table 1.7 for details. Based on the results of the analysis, we found that the stock price was more sensitive to changes in WACC rather than the growth rate. We noticed that for our most likely scenario for the growth rate of 10%, the stock price ranged from $101.57 to $183.49 based on the fluctuations of the WACC while for the most likely WACC of 9.45%, the stock price ranged from $129.59 to $136.96 based on the fluctuations of the growth rate. Not surprisingly, we also noticed that as the growth rate increased, we saw a corresponding increase in the stock price.

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SECTION 8: RECOMMENDATIONS
Like the rest of the industry, FedEx was hit hard by high fuel costs at the beginning of 2008, which transitioned to lower consumer demand for its express services during the end of the year. Coping with the crisis, at the end of 2008 FedEx implemented a hiring freeze, suspended 401K contributions, and reduced its workforce throughout 2009. With the improvement in the global economy we have noticed an increase in the global shipping volumes. To accommodate the expansion, FedEx Express added flights between Asia and the US, and between Asia and Europe in 2010. Based on its 2008 worldwide expansion plan, FedEx Express has turned its eye toward international expansion, necessitating increasing its fleet. The company ordered 38 Boeing 777 air freighters, six of which were delivered by mid-2010. FedEx Trade Networks, a major provider of freight forwarding and customs brokerage services, operates as part of FedEx Express and has been up front and center with the Asian expansion. On the US front, the company signed a deal with OfficeMax in mid-2009 to provide shipping services to all of its more than 900 retail stores. The agreement enhances FedEx's already vast retail FedEx Office network. Not content to expand its operations externally, Fed is improving its operations internally as well. To take advantage of synergies among its businesses, FedEx has realigned its operations with added focus and investment in its express segment. We recommend buying FedExs stock. Our conclusion is based on a WACC calculation of 9.45% and growth projections of 10% in 2010 to 12% in 2014 and future growth rate of 4%. According to our assumptions and calculations we value FedEx stock at $132.59. The current stock price on March 14th for FedEx (FEDEX) is at $88.63 and the 52 week range is $70 $98.50. Comparing this value to our estimated share price indicates the shares are undervalued, providing a compelling incentive for investors to buy FedEx shares. Based on our analysis we provide a STRONG BUY recommendation for this stock. We have also found that 18 out of 24 analysts have a consensus of strong buy with the 12 month target price range consensus of 115.

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REFERENCES
1. FedEx Corp. Stock Report, Standard & Poors, March 17, 2011. 2. The Buzz. FedEx delivers good news for economy, CNNMoney, March 17, 2011. < http://money.cnn.com/2011/03/17/news/economy/thebuzz/index.htm> 3. High Oil Could Deliver a Blow to FedEx, Wall Street Journal, March 17, 2011. Print. 4. Federal Express Corporation, Hoovers Company Records, April 5, 2011. 5. FedEx 2010 Annual Report (10K), FedEx Corporation, July 15, 2010

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