I've been a FedEx (NYSE:FDX) skeptic for some time now, and despite a few spikes in February and March, the stock has mostly chopped around in 2012 as investors try to digest the impact of slowdowns in Europe and China on global transportation. Although I still believe that FedEx enjoys too much benefit of the doubt with the sell-side analyst crowd, I do acknowledge the value in this company's nearly impossible-to-replicate infrastructure and its leverage to an eventual economic recovery. Overall, maybe FedEx is getting within sight of being attractively valued.

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An in-Line Quarter (Sort of...)
FedEx's reported results on Tuesday were basically in line with expectations, though those expectations were guided down about 8% earlier this month on weaker demand and higher expenses. Overall, revenue rose 3% this quarter, with 8% growth in Ground and 5% growth in Freight offsetting feeble 1% growth in the Express business. Volumes were somewhat in line with the revenue performance. In Express, domestic volume dropped 5% while International volume improved 1%, as 10% growth in International Economy offset a 5% decline in the larger International Priority business. Ground volume was up 5% (with SmartPost up 18%), while Freight volume improved 1%, as a 4% decline in International Airfreight offset a 3% increase in average daily U.S. pounds.

Profits were not so strong. Operating income rose just 1%, as meaningful improvements in profits in Ground and Freight (9% and 114%, respectively) were offset by a 28% decline in Express. FedEx management singled out lower U.S. volumes and shifts to more economically priced (and thus lower-yielding) international offerings.

SEE: Evaluating A Company's Management

No Good News on the Horizon
FedEx accompanied its fiscal first quarter report with another downward revision in guidance. While management's numbers gave no assumed benefit to restructuring, it represents another 10% revision and demand apparently continues to slow. At this point, I'm not sure how conservative FedEx management is being with its numbers. Recently data from both Shanghai Pudong International Airport Cargo Terminal (PACTL) and Hong Kong Air Cargo Terminals Limited (HACTL) has not been especially strong, with August numbers at HACTL showing a 13% decline in export volume and below-seasonal performance. While they're different businesses, FedEx's international business and the air cargo businesses of Atlas Air (Nasdaq:AAWW) and Air Transport Service Group (Nasdaq:ATSG) tend to follow the trends at these cargo terminals.

Everybody is still waiting for air cargo to recover. While fourth quarter export comps for China and Hong Kong should be easy and the launch of the next Apple (Nasdaq:AAPL) phone should boost demand, trends aren't healthy. Chip companies are reporting slow order growth as customers run down inventories and despite trends led by companies like Nike (NYSE:NKE) and pharmaceutical companies towards air freight, many companies are switching to ocean freight to take advantage of much lower rates.

Still Too Much Optimism?
Although U.S. land-based transportation companies like Old Dominion (Nasdaq:ODFL) and Union Pacific (NYSE:UNP) have outperformed FedEx to date, I still think I'd prefer to own them over FedEx. While FedEx has a great brand and a fantastic global reach, the company has just never been great at producing robust returns on capital or high free cash flow margins. To be fair, the numbers have been improving significantly over the last three years, but sell-side analysts are still projecting numbers that FedEx has heretofore never shown it can deliver.

The Bottom Line
Just for argument's sake, I'll go with the sell-side expectation that FedEx can basically double its free cash flow margin and hold that level, while also growing revenue at a mid-single digit rate. Do that and you get a forecast of roughly 14% compound annual free cash flow growth for FedEx over the next decade. That ultimately translates into a fair value in the mid-$90s. Looking at the numbers a little differently, FedEx may also be cheap on an EBITDA basis.

If you give FedEx the sort of EBITDA multiple that global air cargo companies get (around five times), you get a similar target in the $90s, while a more normalized multiple of seven times (normalized for transports) would send that target close to $130. I do think FedEx's history of lower returns merit a lower multiple, but across multiple metrics FedEx may at long last be trading at a discount - not enough to entice me to buy, but the best investors have seen in some time.

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

Tickers in this Article: FDX, AAWW, ATSG, UNP, AAPL, NKE, ODFL

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