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At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." Today, we'll show you whether those bigwigs actually know what they're talking about. To help, we've enlisted Motley Fool CAPS to track the long-term performance of Wall Street's best and worst.
And speaking of the best...
There aren't a lot of analysts on Wall Street that can say they get twice as many stock picks right as they get wrong. But there is one, and as luck would have it, this one just made a rather bold prediction about a stock I'm pretty sure you've heard of.
Yesterday, the analyst in question -- Standpoint Research, rated in the top 20% of analysts we track on CAPS, and boasting a record of 66% accuracy on its picks -- cited FedEx's (NYSE: FDX ) latest cost-cutting plan as a major reason behind its upgrade.
This is the plan
As you've probably heard by now, FedEx announced earlier this week that it will replace some 5,000 older delivery trucks, and several airplanes, with newer models. FedEx is also laying off workers (no word on whether it's looking to replace those with newer models as well). And according to management, this is all part of a grand plan to cut the company's annual operating costs by $1.7 billion by 2015.
According to StreetInsider.com, Standpoint is calling the plan "very significant and a game changer. Even if the $1,700,000,000 in cuts are not completely made, and even if there is a slight revenue decline coinciding with these cuts, these moves all but guarantee that FDX will deliver EPS topping $10.00 in 2015-2016." The analyst believes that such a boost will make the stock worth $130 a share, and set its price target accordingly. And if all goes according to plan, yes, this makes sense.
After all, FedEx is already trading at a sizable discount (a 14 P/E) to archrival UPS (NYSE: UPS ) , which costs 18 times trailing earnings. What's more, the $10 a share in GAAP earnings that Standpoint predicts work out to about a nine times "forward P/E ratio" on FedEx stock.
And this is why the plan won't work
On the other hand, though, this is nine times very forward earnings we're talking about. Earnings, in fact, that won't be earned for three more years -- if they're even earned then. Now, FedEx bulls may point out that if FedEx succeeds in transforming all $1.7 billion in planned cost-cuts into additional free cash flow, then this number plus the $1 billion FedEx showed it could generate over the past 12 months would be a tidy $2.7 billion, and give the stock close to a 10 times price-to-free-cash-flow ratio on its price today.
But here's the thing: It won't work out that way. Not even close. Consider: Cutting 5,000 obsolete trucks, and multiple old aircraft as well, is all well and good. But FedEx still needs something to haul its packages around in. The newer model trucks and planes it intends to acquire to replace those that retire are all going to cost money. Significant money, and money that promises to drain significant sums from FedEx's operating cashflows, quite possibly resulting in free cash flow that's lower than what we see today, rather than higher.
The best laid plans of mice and management
In fact, we've seen how plans like these have played out before. Remember, for example, when Yahoo! (Nasdaq: YHOO ) billed its plan to outsource search functioning to Microsoft (Nasdaq: MSFT ) as a way to cut costs and boost cashflows by $500 million per year? Remember how that worked out?
Hint: It didn't, or at least not for Yahoo! Since making its promise back in 2009, Yahoo!'s cashflow has pretty much stagnated, while capital spending has actually gone up 8%. (Mr. Softy, on the other hand, has steadily increased free cash flow, while cutting capex).
And that was in the asset-lite tech industry, where most assets take the forms of 1's and 0's, and cutting capital costs should have been a cinch for Yahoo! In an industry like transport, by contrast, hard assets are the name of the game. Trucks to roll hard goods along the highways. Planes to ship iPhones from China. These things cost real money, real capital spending, and it's hard to see how saving a few bucks on gasoline costs by buying more efficient trucks will make up the difference -- much less make a $1.7-billion-a-year difference.
Make no mistake -- I'm in favor of FedEx cutting costs. I'm in favor of FedEx increasing profits. And if, come 2015, FedEx actually succeeds in generating $2.9 billion (or more) in free cash flow, and is selling for about 10 times that number, whatever it turns out to be, I'll be first in line recommending you to buy this leading transport provider at its then-bargain price.
But for now, the future's uncertain, and the chance that FedEx can avoid "pulling a Yahoo!" far from clear. Based on today's numbers, its stock's still no buy.
Could Microsoft be a better bet than FedEx? How did Mr. Softy outwit its partner, and succeed in growing cashflow and cutting costs, where Yahoo! failed? Find out, and check out the future for this leading software company in our brand-new premium report on Microsoft, where our analyst lays out the opportunities and risks for Microsoft. We're also providing regular updates as key events occur, so make sure to claim a copy of this report now by clicking here.