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Why FedEx Has a Low Valuation Premium Compared to Peers

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FedEx’s unique strengths

FedEx (FDX) is the number two global integrated logistics service provider after United Parcel Service (UPS). It is a major North American less-than-truckload carrier competing with XPO Logistics (XPO) and YRC Worldwide (YRCW). About 77% of its customers make use of services from all three operating subsidiaries. Plus, FDX derives 96% of its US revenue from customers in two or more operating companies.

Why FedEx Has a Low Valuation Premium Compared to Peers

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Forward price-to-earnings multiple

Forward PE (or price-to-earnings) multiples represent the dollars payable today for every dollar of next year’s earnings per share. FDX’s current forward PE multiple is 13.7x, whereas the peer group’s current average forward PE multiple is 17.7x, which represents a discount of 22.6%.

FedEx’s peers include UPS, Yamato Holdings, and TNT Express. For Yamato and TNT Express, the net debt is negative while UPS and FDX have a positive net debt. Plus, UPS’s free cash flows have been better than FDX’s in the past few years. This is mainly due to the less capital expenditure incurred by UPS in the last ten years.

Low valuation premium

UPS has a younger fleet of aircraft than FDX has. FedEx needs to spend a huge chunk to replenish its aircraft, which is also one of the company’s major concerns. Given its amount of cash flows from operations compared with UPS, investors are skeptical about the growth of its free cash flows going forward. In addition, FDX’s fuel expenses as a percent of revenues are higher than that of archrival UPS. If global oil price movement reverses its stance in the near term, then UPS is more likely to emerge as a winner on this front.

One more reason for FDX trading at a discount to peers, especially UPS, is operating efficiency. While UPS’s adjusted operating and net income margins are higher than FDX’s adjusted margins, FedEx’s 2016 EPS is expected to grow at 18% compared with UPS’s 6% rise in EPS during the same period. UPS’s return on assets of ~11% is higher than FDX’s 6.5%.

Amazon (AMZN) recently entered into an agreement with Air Transport Service Group (ATSG) to lease a 20 Boeing 767 (BA) wide-body freight aircraft to handle Amazon’s own deliveries in the US. Interestingly, in the 3Q16 earnings call, FDX’s management spent a considerable amount of time explaining that it expects Amazon to remain a large customer and partner in the long run. As the story behind Amazon’s stake in ATSG will unfold slowly, FDX’s price may adjust a bit on this front.

Investors seeking diversified industry exposure can consider the Guggenheim S&P 500 Equal Weight ETF (RSP). This ETF invests 0.22% in FedEx. Transportation-sector-specific investors can opt for the Industrial Select Sector SPDR Fund (XLI), which invests 2.3% in FDX.

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