How I Fixed My FedEx Valuation Issue

In my recent Two Questions I Ask Before Investing Money post I touched upon the Return versus Risk aspect of an investment. I followed up that article with my Buying Stocks When Valuations Are High where I discussed three possible approaches to investing; I indicated the Valuation approach is my preferred method. Sometimes, however, you analyze a company using the Valuation approach and something happens to the company which causes its performance and share price to suffer. This happened to me with FedEx Corporation (FDX). Here is how I fixed my FedEx valuation issue.

Background

FDX has a portfolio of solutions that can tackle any challenge in the world of global commerce. Each network operates independently but works collaboratively.

FedEx - Broad Portfolio of Services

Source: FDX Corporation Investor Relations Presentation - March 18, 2021

In my March 23, 2017 FedEx Stock Analysis – A Lesson in Long-Term versus Short-Term Thinking post I indicated I had initiated a FDX position on March 23, 2017 @ $194.77. This position was initiated in an account for which I do not disclose details. I subsequently acquired additional shares @$185.31 on April 20, 2017.

In the summer of 2017, FDX disclosed that a disruption in services in its TNT Express unit following a cyberattack in June would hurt its full-year results. Despite this, I still liked FDX as a long-term investment so I acquired more shares and wrote a follow-up FedEx – Looking at the Big Picture June 20, 2018 article.

I followed up that article with my September 22, 2018 FedEx – Adding to My Existing Position post.

The cyberattack turned out to be far more disruptive than imagined and far more expensive to resolve. My view of FDX as a long-term investment had not changed so I acquired more shares and wrote FedEx – Tough to Overlook at Current Valuation…So I Bought More on December 11, 2018 and FedEx – Added to My Position Following ~12% Pullback on December 19, 2018.

FDX's share price continued to drop in 2019 and on June 26, 2019 I wrote FedEx Corporation – Be Grateful When Good Companies Fall Out of Favor.  and on September 18, 2019 I wrote FedEx Corporation – Short-Term Headwinds Create A Long-Term Investment Opportunity.

Every time I wrote an article I acquired an additional 50 shares. On September 18, 2019, however, I acquired an additional 200 shares.

This is a list of my purchases and the average share price per purchase. The weighted average price of the following purchases is ~$176:

  • June 25, 2018 $234.94
  • September 20, 2018 $243.12
  • December 11, 2018 $187.69
  • December 19, 2018 $165.92
  • June 26, 2019 $157.97
  • September 18, 2019 $148.94

Lower The Average Cost

As I indicated earlier, FDX experienced some very serious issues at its TNT Express unit that would cost a fortune to repair. Because of this, many investors kicked FDX to the curb. As FDX's share price continued to drop I chose to view the share price decline as a buying opportunity. I was reasonably confident the company would eventually fix the issues created by the cyberattack. The company just needed to deploy a lot more resources than originally anticipated to fix the matter.

Financial Review

Q3 2021 Results

Fast forward to March 18, 2021 when FDX released Q3 2021 results.

FDX is still incurring TNT Express integration expenses ($0.14 per diluted share in Q3 2021). These expenses, however, have declined significantly relative to Q3 2017 - 2020 ($0.23, $0.34, $0.21, and $0.21 per diluted share).

FDX's results would have even been better but severe winter weather during February reduced Q3's operating income by ~$0.35B. The weather significantly impaired operations at several of FDX's largest facilities, including the primary FDX Express hub in Memphis and FDX Express hubs in Indianapolis and North Texas.

FY2021 Guidance

FDX has forecast FY2021:

  • Adjusted diluted EPS of $16.80 - $17.40 before the year-end mark-to-market (MTM) retirement plan accounting adjustment and debt refinancing costs that may be incurred;
  • Adjusted diluted EPS of $17.60 - $18.20 before (1) the year-end MTM retirement plan accounting adjustment and (2) debt refinancing costs that may be incurred and excluding (3) TNT Express integration expenses; (4) costs associated with business realignment activities; and (5) and Q2 2021 MTM TNT Express retirement plan accounting adjustment;
  • An effective tax rate of 21% - 22% before the year-end MTM retirement plan accounting adjustment; and
  • $5.7B of capital spending. This is an increase from the prior forecast due to changes in the timing of aircraft payments and the acceleration of FDX Ground capacity expansion initiatives.

Free Cash Flow (FCF)

Looking at FDX's Condensed Consolidated Statements of Cash Flows (page 7 of 79) in the Q3 2021 10-Q we see YTD FCF of $3.19B.

We can see from FY2011 - FY2020 results that FDX's business is highly capital intensive. CAPEX during this timeframe (in billions) was $3, $4, $3, $4, $4, $5, $5, $6, $5, and $6.

FCF during the same timeframe amounted to: $0.607B, $0.828B, $1.313B, $0.731, $1.019B, $0.89B, ($0.186B), ($0.989B), $0.123B, and ($0.771B).

Risk Assessment

Investors should analyze an investment from a return versus risk perspective. I look at the company's credit ratings assigned by the major rating agencies as part of my risk review. These rating agencies rate debt but I know my equity investments carry more risk. This is why I strongly favour investment-grade companies.

Details of FDX's financing arrangements can be found in the Q3 10-Q commencing on page 13 of 79. Looking at the long-term debt notes in the Q3 10-Q, it is apparent FDX operates in a highly capital-intensive industry. This is not surprising given its fleet of vehicles and aircraft. On page 30 of 163 in the FY2020 Annual Report, we see that FDX owns 646 aircraft and leases 33.

FDX's domestic senior unsecured long-term debt ratings are:

  • Moody: Baa2 - rated March 15, 2016 and affirmed April 2, 2020.
  • S&P Global: BBB - rated February 2, 1998 and last reviewed August 7, 2020

Both ratings are the middle tier of the 'lower medium grade' category. At this level, an obligor has ADEQUATE capacity to meet its financial commitments. Adverse economic conditions or changing circumstances, however, are more likely to lead to a weakened capacity of the obligor to meet its financial commitments.

These ratings are satisfactory for my prudent investor profile.

Dividends and Dividend Yield

FDX is a company on which dividend income investors will likely take a pass. The company's quarterly dividend has been frozen at $0.65 for 12 consecutive quarters. Furthermore, with shares currently trading at  ~$272, the dividend yield is less than 1%; the dividend freeze and the low dividend yield do not concern me. I would much rather FDX retain funds in the company to improve operations and to make itself a stronger company.

Share Repurchases

The weighted average number of issued and outstanding shares in FY2011 - FY2020 (in millions) was: 317, 317, 317, 310, 287, 279, 270, 272, 265, and 262.

Valuation

In the first 3 quarters of the current fiscal year, FedEx has generated $12.55 in diluted EPS which is well over the $4.90 generated during the same timeframe in FY2020.

Adjusted diluted EPS guidance of $16.80 - $17.40 (before the year-end mark-to-market (MTM) retirement plan accounting adjustment and debt refinancing costs that may be incurred) has been provided. In FY2020, FDX incurred a $2.22 mark-to-market retirement plan accounting adjustment. If we conservatively assume an adjustment of $2.50 for FY2021, then FY2021 diluted EPS before debt refinancing costs that may be incurred will likely be ~$14.3 - ~$14.9.

Shares are currently trading at ~$272 so the forward diluted PE will likely end up in the ~18.26 - ~19 range.

One of my sources shows that 23 brokers have provided FY2021 adjusted mean, low/high estimates of $17.91, $16.85 - $18.25. On this basis, FDX's forward adjusted diluted PE is ~15 - ~16.1 with a mean of ~15.2.

By way of comparison, FDX's FY2011 - FY2020 diluted PE was 15.18, 14.72, 27.81, 22.01, 37.81, 27.02, 22.98, 8.79, 432.03, and 28.25.

Conclusion

In my recent Focus On Total Return To Better Manage Your Investments post I compared the long-term performance of companies with low versus high dividend yields in which I have invested. FDX is another example of a company in which I invested where I deem the low dividend yield to be a non-issue.

I admit FDX's share price has been more volatile than I expected. Then again, I have invested in the company with the long-term in mind so stock price gyrations are of little concern to me.

You can see from my FDX transaction history how I fixed my FedEx valuation issue. I essentially acquired additional shares when the company fell out of favour with the investment community. My average cost on 451 shares held in the FFJ Portfolio is ~$176 and shares are currently trading at ~$272. That is a far better return than I could have expected from any dividend increases during the last couple of years.

I have not sold any FDX shares, and therefore, have incurred no tax liability on the appreciation in the value of my FDX holdings. I have, however, incurred a 15% dividend withholding tax on every quarterly dividend payment received. This dividend income is included in my annual tax return so I give a bit more of 'my hide' to the tax authorities than the 15% withholding tax.

I hope my experience with FDX makes you pause and think that chasing attractive dividend-yielding stocks might not always be the best strategy.

Finally, I am currently not looking to add to my FDX position. The company's fiscal year-end is at the end of May and results are released at the end of June. I will wait to see what accounting adjustments are made before I decide if I will acquire additional shares.

Stay safe. Stay focused.

I wish you much success on your journey to financial freedom.

Disclosure: I am long FDX.

Note: Please send any feedback, corrections, or questions to [email protected].

Disclosure: I disclose holdings held in the FFJ Portfolio and the dividend income generated from these holdings. I do not disclose details of holdings held in various tax-advantaged accounts for confidentiality reasons.

Disclaimer: I do not know your individual circumstances and do not provide individualized advice or recommendations. I encourage you to make investment decisions by conducting your own research and due diligence. Consult your financial advisor about your specific situation.