Any way you look at it, FedEx (NYSE: FDX ) should be a sell.
The No. 2 name in parcel shipment generates miniscule free cash flow relative to its revenues. Its bungled Kinko's acquisition has resulted in plummeting profits and billions of dollars in goodwill writedowns, with the result that FedEx has no P/E to speak of today. And even for investors who place faith in forward estimates, the stock's 20 P/E (based on next year's earnings) seems indefensible in light of consensus expectations for single-digit per annum growth over the next five years.
But would I actually go out and sell FedEx if I owned it (or short it, since I don't)? Not on your life.
Once upon a time, a wiser Fool than I laid out in painful detail why Valuation Matters, and how investing in "obviously" overpriced stocks like FedEx can be hazardous to your wealth. But here's something he didn't mention: Expectations matter just as much as valuation. And if you look real close, I think you'll agree that the expectations currently attached to FedEx stock are way low.
According to the consensus of the two-dozen odd analysts who follow this stock, FedEx is only going to grow 6.4% per year over the next five years. For whatever reason, the market believes this justifies a 20 forward P/E on the stock, and refuses to be shaken from that belief. So what, a Fool may wonder, will happen if FedEx can easily outpace that growth?
Yesterday, FedEx followed in UPS's (NYSE: UPS ) footsteps by announcing a 2010 rate hike of approximately 5% across the board on its various shipping options. Assuming no growth in the volume of packages FedEx ships, and no loss of market share to UPS, this rate increase alone would seem to put the majority of FedEx's growth expectations "in the bag."
And yet ...
Raise your hands if you expect FedEx to lose share to UPS, when both services are raising their rates in lockstep. No takers? OK, so who among you thinks the total volume of packages shipped is going to stagnate or decline?
Last month, Goldman Sachs (NYSE: GS ) cast its vote when it ratcheted up earnings expectations for both cardboard manufacturers like International Paper (NYSE: IP ) (most packages being made of cardboard) and package senders like Amazon.com (Nasdaq: AMZN ) . Seems the highly publicized price wars with Barnes & Noble (NYSE: BKS ) and Wal-Mart (NYSE: WMT ) are driving extra traffic Amazon's way. But more generally, and as I explained in a column entitled What in the World Is Goldman Sachs Thinking?, Goldman was making a bet on near-term growth in parcel shipment -- a trend that, if it proves out, would be good news for both UPS and FedEx.
Meanwhile, the U.S. Postal Service (USPS) (if you don't know who they are, go ask your grandma) just admitted that it lost $3.8 billion in fiscal 2009, and unless something changes quick, it's on track to more than double that loss in 2010. Avoiding a loss will require some combination of cutting benefits to its employees and reducing service to its customers -- there's even been talk of downshifting to a five-day workweek for mail carriers. And while USPS isn't using the "R" word just yet (for rate hike), you can pretty much bet that's in the cards as well.
So I ask you, what effect do you think will come of antagonizing USPS workers with benefit cuts, cutting service days by nearly 20%, and potentially raising prices?
Raise your hands
If you answered: "Salvation and perpetual solvency for the United States Postal Service," then congratulations. You just might qualify for the job of Postmaster General.
On the other hand, if you answered: "More business for UPS and FedEx," then go to the head of the class, because that's the right answer. The worse the quality of the second "S" in USPS, the more you can expect customers to seek out private sector solutions for their shipping needs. And the more USPS hikes rates on its deliveries, the more cover UPS and FedEx will have for continuing to raise their own prices.
Any way I look at it, FedEx stock is overpriced. But at the same time, any way I look at it, it seems destined to remain that way.
Everything I see happening in the delivery space -- lockstep price adjustments by its archrival UPS, and possible price hikes at USPS -- works to protect FedEx's ability to raise the price of its services. And if this recession will ever get around to getting-over-with, the prospects for growing package volume at at least the rate of population growth, plus boosting that growth with market share stolen from USPS, seems equally certain.
Long story short, there's just about zero chance that this company will be stuck at under 7% growth over the long-term. Once the Wall Streeters realize this, they're bound to raise their growth expectations -- and FedEx's share price is bound to follow.