Some investors believe that it's best not to overthink things or rely too much on cold numbers. Instead, they believe in buying into brands, business models and growth stories, with the idea being that the numbers eventually work themselves out. Much as it goes against my strong stock fundamentalist instincts, I can see a point here with a stock like FedEx (NYSE:FDX). Clearly, this company's brand and enormous global logistics infrastructure is worth quite a lot. Yet, the company's past returns on capital and free cash flow margin would suggest that today's apparently low valuation metrics deserve to be even lower still. (For related reading on free cash flow, see Free Cash Flow: Free, But Not Always Easy.)

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An Encouraging Second Quarter
FedEx showed meaningful progress on numerous fronts in its fiscal second quarter. Overall, revenue rose about 10% and this growth was well-balanced across the units. The very large Express business, which accounts for more than 60% of total revenue, saw growth of 10%, while the smaller Ground and Freight businesses grew 13 and 9%, respectively.

Profit growth was also solid in this quarter. Adjusted operating income grew about 26% versus the reported growth of 66%, and all of the company's businesses showed progress and improved operating margins.

Ground Good, Express Next?
FedEx has done a very good job of improving the results coming out of the Ground business. Not only was revenue per package up 8% and volume up a further 4%, but the unit's margins expanded to a company-high 17%. Certainly FedEx owes some of this to the likes of Amazon (Nasdaq:AMZN) and the overall growth of e-commerce and home delivery. Credit is also due, though, to a lot of below-the-water operating efficiency improvements.

Can the Express business follow this path? The nature of the business argues that it can't have quite the same efficiencies as the Ground business, since delivery time is such a preeminent consideration. Still, with an operating margin of just over 5% and some weakness of late in volume, it is easy to argue that more should be expected. Still, maybe competitive actions from the likes of UPS (NYSE:UPS) do limit just how much the company can change here.

Does Freight Make Sense?
I still question whether or not it makes sense for FedEx to be in the less-than-truckload trucking business. Simply put, while they're very big, they're not necessarily great at it. Yield was up about 8% this quarter and the company did reverse a year-ago loss. Still, it is hard to argue that they are as good at this line of business as Old Dominion (Nasdaq:ODFL), Con-way (NYSE:CNW) or Arkansas Best (Nasdaq:ABFS) and I cannot see how the company is earning its cost of capital here.

The Bottom Line
FedEx gets puzzling when it's time to figure out an appropriate value. After all, a trailing EV/EBTIDA of less than six and an EV/Revenue of less than one, not to mention a PEG ratio below one, argue that the stock is too cheap. Unfortunately, the return on invested capital here is stubbornly below that 10% breakpoint that "good companies" usually produce. Certainly inefficient and asset-intensive operations like the Freight business don't help matters. (For related reading, see How To Use The P/E Ratio And PEG To Tell A Stock's Future.)

There's a wide spread on analyst cash flow estimates for FedEx over the next three years and where there's divergence there's often opportunity. If FedEx can drive better efficiency and double its historical free cash flow margin, this stock is indeed too cheap. But if FedEx cannot produce better margins and returns on capital, it's hard to argue that those low fundamental value metrics aren't deserved. After all, what good is a state-of-the-art, horribly expensive-to-reproduce infrastructure if a company cannot generate compelling returns from it?

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At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.

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