Based on FedEx’s revised Q3 F2018 earnings, on Wednesday Morningstar, Merrill Lynch, Stifel, and Susquehanna revised their price targets for the parcel carrier’s stock (XNYS). FedEx reported an adjusted EPS of $3.72, handily beating the Wall Street consensus at $3.11.
Although the analysts were in agreement that FedEx is a ‘buy’, there’s a fairly large spread between their various price targets: Morningstar set a conservative price target at $260; Susquehanna came in at $293; Stifel estimated $295; and Merrill Lynch’s bullish ‘fair value’ for FedEx stock was $310. On Thursday, FedEx closed at $236.27, after falling with the rest of the market—the $50 spread between the Morningstar and Merrill Lynch price targets represents 21.1% of the company’s value.
Morningstar’s Keith Schoonmaker wrote about the risk to the FedEx price target: “FedEx is chiefly exposed to the health of the U.S. and global economies. As FedEx expands operations in Europe and Asia, such as China, continuing success depends not only on busy, healthy domestic and global economies, but also on continued stable conditions in these regions,” Schoonmaker wrote. Regarding FedEx’s ability to improve one of its recently acquired units, Schoonmaker pointed out that “With the TNT Express acquisition completed in 2016, the firm will need to contend with European unions as it works to improve TNT’s lagging margins.”
Bascome Majors, equity analyst for Susquehanna International Group, commented that the margin expansion in FedEx’s ground division and the unexpected drop in capex more than outweighed weaker Express margins. The tax reform bill passed by the Republican Congress allowed companies to deduct 100% of the depreciation costs of new equipment purchases in the first year: this was intended to encourage manufacturers to pull the trigger on machine upgrades and boost productivity. But the tax break may have less of an effect on transportation companies, who have carefully planned the pace of their fleet turnovers and already optimized their depreciation schedules. Susquehanna expected FedEx to increase its capex on the tax reform benefit, which would have put downward pressure on their earnings, but instead FedEx decreased its capex by $100M to $5.8B.
“The reduction is primarily due to lower expected spend for Ground as management capitalizes on prior years’ significant investments. Of note, while FedEx expects to give FY19 capex guidance in June, management noted that total spend for the year wouldn’t be ‘much different’ from this fiscal year,” Majors wrote.
Stifel’s target price at $295 was very close to Susquehanna’s $293. In Stifel’s bull case, the TNT integration will be successful, Express Profit Improvement 2.0 hits its mark, Ground margins recover to the mid-teens, and tax cuts spur economic growth. In Stifel’s bear case, the business cycle rolls over, causing operating leverage to work against FedEx, ground margins remain soft, TNT integration proves unexpectedly challenging, and Express margins fail to hit their improvement targets.
“The company gave out rare next-quarter segment margin guidance that was similar to this quarter's result, in our view - better than expected in Ground and below expectations in Express and Freight - but translating into a higher EBIT number (~$2bn) than we were modeling (~$1.85bn). Because we like the company's general earnings trajectory (#s going higher) and think the stock moves up from here with growth, we are upgrading the shares to Buy,” wrote Stifel’s equity analyst David Ross.
Merrill Lynch was the most bullish on FedEx stock with a price target of $310. “Owing to its global infrastructure, FedEx, one of the three main global airfreight integrators, benefits from growth of cross-border trade. As the economy rebounds, FedEx's fixed network benefits from improved utilization,” wrote Ken Hoexter, research analyst for Merrill Lynch. “Risks to our price objective are slower than expected growth in the U.S. and global economy, increasing barriers to global trade (protectionism), a quick rise in fuel prices, increased volume and price competition, a return of union pressure on the company's Ground and Express employees, and continued unionization at its Freight segment,” wrote Hoexter.
Analysts agree that the biggest risks to FedEx’s valuation come from the turning of the economic cycle and a resurgence of protectionist trade policies. The ‘economic moat’ protecting FedEx from new competitors was tested during DHL’s failed entry into North American parcel delivery ten years ago. But DHL is moving again: announcing last week that it would offer a delivery service for online retailers in eight U.S. cities.
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