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FedEx Retains Neutral Tag

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On Jan 17, 2014, we reaffirmed our Neutral recommendation on FedEx Corp. (FDX - Free Report) . Although the company’s second quarter fiscal 2014 earnings missed the Zacks Consensus Estimate, the bottom line remained above the year-ago level. Despite the challenges in the macro economy, the company delivered strong earnings year over year on the back of higher revenues at the Ground and Freight segments coupled with cost control efforts at the Express segment. Revenues registered year-over-year growth but remained below our expectation.  

The Zacks Consensus Estimate for the third quarter earnings is pegged at $1.57 per share.  

Why Retain?

We expect growth at FedEx to continue in the upcoming quarters, driven by the ongoing improvements across all its segments. As a result, the company has also increased its estimated fiscal 2014 earnings growth to 8–14% per share from 7–13% expected previously. While the company is counting on its profitability improvement to support higher earnings estimates, it is also considering ongoing share repurchase program.

The company, as of Nov 30, 2013 repurchased 10 million shares, which include 7.2 million shares repurchased in the second quarter. FedEx expects the buyback made in the second quarter to positively impact earnings by 4 cents per share. The company currently has 32.2 million shares under its current repurchase authorization, of which it expects to buy back 11.4 million shares to an aggregate of $2 billion by the end of fiscal 2014. 

FedEx, which operates with other carriers like United Parcel Service, Inc. (UPS - Free Report) and Radiant Logistics, Inc. (RLGT - Free Report) and Expeditors International of Washington Inc. (EXPD - Free Report) foresees modest growth in the global economy, driven by gradual improvements in Europe and China. Based on this, the company remains positive over growth in real GDP, industrial production, and consumer spending in calendar year 2014 and 2015 in the U.S. and globally. FedEx foresees global GDP growth of 2.8% and 3.2% for calendar year 2014 and 2015, respectively.

FedEx also assumes U.S. GDP growth of 2.4% for calendar year 2014 and 3.0% for 2015. Further, industrial production growth is estimated at 3.1% and 3.6% in calendar years 2014 and 2015, respectively. The company is also banking on new business wins. In Sep 2013, FedEx won a $171 million contract from the U.S. Department of Defense for small package delivery services for the military. This contract expires on Sep 30, 2014. FedEx also won a second defense contract worth $49.8 million for overpacking and transportation of perishable products for the Defense Commissary Agency and Defense Logistics Agency, effective Oct 1, 2013. Unless extended, the contract will expire on Sep 30, 2014.

However, we expect the global economic environment impacted by the European debt crisis and tardy Asian growth to remain detrimental to the company’s demand function. As a result, FedEx will likely witness a demand shift from premium services to deferred services within FedEx Express as customer preferences drift toward lower-yielding international services, lower rate per pound and weight per shipment. This will ultimately have a negative impact on operating margins.

The company expects subdued revenue performance in the Freight segment in fiscal 2014 due to poor market demand in Less-Than-Truckload (LTL) services. Depreciation expenses are also expected to increase due to accelerated retirement of old aircraft, which would cost around $74 million in fiscal 2014. As a result, we maintain a cautious stance on the company over the near term.

The company currently has a Zacks Rank #3 (Hold).

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