FedEx

Date: September 23,2019 Price: $146.23

Company Profile

Fedex was founded by CEO Fred Smith in 1971. Smith crafted the idea for FedEx in a term paper
he wrote while he was a student at Yale. FedEx has come into trouble recently with the economic
slowdown as well as the slower than expected integration of TNT Express (an international courier
delivery services company now a subsidiary of FedEx.) Competition in the delivery space is
increasing as UPS strengthens its air network while spending $7 billion on CapEx and Amazon
builds out its own delivery network. FedEx occupies a niche as they control 75% of the Business to
Business delivery market.

FedEx operates in four avenues. 1.) Express business delivery is centered around overnight air
freight. 2.) FedEx ground operates a just in time model for parcels through the use of independent
contractors. 3.) FedEx Freight is the largest Less-than-truckload carrier in the U.S. 4.) FedEx
services includes such entities as FedEx office which is a loss leader but is valuable to the FedEx
network because it is the channel the most profitable packages come through. The ability of FedEx
to bundle Express, Ground and Freight is one of its competitive advantages.

The express business has been under strain as profits have been lower due to the slowdown in
global economic growth as well as the split with Amazon. The company is cutting costs as a result:
on top of offering employees a buyout they have been retiring planes and plan to ground others
after the holiday season.

FedEx Ground has grown its revenue but has been investing heavily and is integrating SmartPost
into Ground. FedEx SmartPost is a package consolidator that uses FedEx for long distance
transportation and USPS for final delivery. FedEx will bring the 2 million packages it hands off to
USPS into its own network. USPS is weakening as a competitor as it experienced a reduction in
packages for the first time in nine years as private delivery carriers bring this function in house.

FedEx ended its contract with Amazon forgoing almost $1B in revenue. Current management has
downplayed this loss in revenue as well as Amazons competitive threat. However, in a more recent
conference call FedEx CEO acknowledged five players in the U.S. delivery market DHL, UPS,
USPS, Amazon and FedEx. FedEx is looking to align itself with other retailers such as Walmart and
Target.

Financials & The Future

Ground has been a higher margin business than Express. Express has an operating margin of 5.7%
on revenues of $37 Billion. Ground has an operating margin of 12.9% on revenues of $20 Billion.
Freight has an operating margin of 8.1% on revenues of $7.5 Billion.

The e-commerce market is predicted to grow from 50 million to 100 million packages per day by the
year 2026. To lead in e-commerce, FedEx has announced seven-day delivery as well as announcing
FedEx Extra Hours (an express service which provides nightly pickup with next day delivery).
FedEx has expanded the FedEx Ground oversized package network.
FedEx is in a prime position to capitalize on its network and provide one day e-commerce
shipping. FedEx's Express network was not designed for e-commerce. With Express, shippers pay a
premium to have goods delivered by 8am or 10:30am. Packages are traveling shorter distances as
distribution centers are much closer to where people live. Packages are also getting lighter. This
caused FedEx to fill its planes with lower yielding e-commerce packages rather than reducing its
fleet. Wing (Google Drone Delivery Program) recently teamed up with FedEx and Walgreens to test
drone delivery. FedEx is also testing the FedEx Same Day Bot- an autonomous delivery device for
last mile delivery. With the wave of automation coming FedEx stands to benefit.

Another competitive advantage for FedEx is the moat around its business. There are cost
advantages stemming from a large distribution network. The incremental profit on each item that is
on a delivery route is extremely profitable. The variable cost of making an extra stop is almost
nothing. If you try to compete with delivery company that has an established distribution network,
you will have large fixed costs that will cause you to lose money until you can scale up. The moat
only increases as FedEx strengthens its ground network. Moats manifest in pricing power. They are
raising prices next year around 5-6% for all three types of shipping that they provide. FedEx may be
over confident in the resistance of their moat to disruption. Amazon has well-earned reputation for
disruption.

Over the past year FedEx capital investment has leveled off as there was a reduction in global
growth. They spent 5.9B last year and expect to spend the same amount this year in modernizing
their automated system through the conversion of sorting facilities as well as the retirement of older
planes. This current outlay will lead to greater efficiency.

Valuation

FedEx stock price has been hurt recently as they revised down earnings, they are now expecting to
generate $11-13 per share for 2020 due to the slowdown in global growth. The CEO has been in his
current position for almost 50 years. He has built a great company however new leadership will
bring a new perspective that will hone the company’s competitive strengths. With FedEx's
management team, entrenched supply chain, great service, and future efficiency the company is a
buy at 12 times forward earnings.