Wall Street can be a surprisingly stubborn place, and many sell-side analysts continue to stubbornly defend FedEx (NYSE:FDX). While the company's performance isn't all bad, and there's clearly value in its large global asset base, it's still difficult to reconcile sell-side affection for this name with likely free cash flow (FCF) growth over the coming decade.

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Mixed Signals for the Fiscal Second Quarter
Even with the impact of Hurricane Sandy, FedEx didn't have a particularly bad quarter. Revenue rose more than expected and the company posted only a slight miss (and apparently would have had a good beat without Sandy). All the same, I don't think investors should ignore the margin trajectories.

Revenue rose 5% as reported this quarter, with Ground segment revenue leading the way with an 11% growth on a nearly 8% increase in volume. Express and Freight both saw a similar 4% revenue growth, with good underlying volume improvement in the Express business.

Margins continue to be a talking point. Reported operating income fell 8%, and the company saw a one point decline in operating margin. Express was the big loser, as segment income fell one-third and the margin fell to a company-low of 3.4%, down about 180 basis points. Ground squeaked out a 4% income gain, though margins fell more than a point. Freight continues to improve, as income rose 90% on a two and a half point improvement.

SEE: How To Decode A Company's Earnings Reports

Volumes Don't Seem so Bad, Relative to the Economy
Like the railroads, FedEx and UPS (NYSE:UPS) are seen as economic barometers insofar as the global economy still relies on the physical movement of "stuff." To that end, while yields looked light, volumes weren't bad.

Express saw a 6% international volume growth (offsetting a 2% decline domestically), while ground volume was also solid. SmartPost continues to grow (volume up 17% this quarter), and the support of companies like Amazon (Nasdaq:AMZN) certainly isn't hurting. Even FedEx's less-than-truckload trucking business (Freight) is doing pretty well against a tough trucking backdrop where only a few names like Old Dominion (Nasdaq:ODFL).

Still Ample Opportunities for Transformation
Part of the bull thesis on FedEx remains centered on the company's potential to do better. Seeing as how the company has posted operating margins above 8 or 9% in the past, it's not an illogical argument that today's overall reported margin of 6.5% leaves ample room for improvement, and that these improvements will drop through to the bottom line and into FCF.

What's more, the company continues to make investments aimed at becoming more and more efficient. For instance, the company has decided to buy another four new 767-300 planes from Boeing (NYSE:BA), and these new planes ought to offer savings in terms of maintenance needs and fuel economy.

SEE: Evaluating A Company's Management

The Bottom Line
My biggest issue with FedEx is what it has always been - a lack of confidence that the company can really produce significantly better FCFs. Taking that order for four new planes as an example, I don't think FedEx ever gets to a point where it's infrastructure building is "done;" rather, the company will always need to reinvest substantial sums to keep the business going. That makes it difficult to arrive at a compelling FCF-derived fair value.

Over the past decade, FedEx has never managed to turn more than 2% of its revenue into FCF. Even if the company can do markedly better - say, converting 5% of revenue into FCF by 2020 - it doesn't leave a lot on the table. Should the company grow FCF at a compound annual rate of 15% (from 2011's level) for the next decade, fair value looks to fall in the low-$90s seen after giving the company a better-than-S&P 500 discount rate.

While I continue to expect FedEx to serve as a bellwether and proxy for the health of the global economy (and I believe traders can trade it effectively on that basis), it still just doesn't make the grade as an undervalued long-term holding.

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

Tickers in this Article: FDX, UPS, AMZN, ODFL

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