In Poor Charlie's Almanac, Charlie Munger talks about one of his favorite case studies on incentives. Although the story happened years ago, it speaks to the foundational culture at FedEx (FDX -0.68%). It's also my favorite mental model on incentives. Here's what Munger said:
The heart and soul of their system -- which creates the integrity of the product -- is having all their airplanes come to one place in the middle of the night and shift all the packages from plane to plane. If there are delays, the whole operation can't deliver a product full of integrity to Federal Express customers.
And it was always screwed up. They could never get it done on time. They tried everything -- moral suasion, threats, you name it. And nothing worked.
Finally, somebody got the idea to pay all these people not so much an hour, but so much a shift -- and when it's all done, they can all go home. Well, their problems cleared up overnight.
So getting the incentives right is a very, very important lesson. It was not obvious to Federal Express what the solution was. But maybe now, it will hereafter more often be obvious to you.
Incentives are an important part of how we make decisions every day. Equally important, in ascertaining the potential for investment, is understanding a company's competitive advantages and price-to-intrinsic value.
Let's examine, then, some reasons that now may be the time to look into FedEx.
Global leader in express transportation
FedEx has grown ground revenue market share for almost 20 years and controls more than 25% of the market. The company gains a significant competitive advantage from transportation infrastructure, with worldwide brand recognition for quality and speed. The company's Express product is an extremely popular feature, with near certain delivery in one to three days, and the company serves countries that comprise more than 90% of the world's GDP.
FedEx's dominance in its ground segment, a primary profit driver, has certainly given the company a leg up on its competition.
Image source: FedEx company presentation.
Positioned well for international and e-commerce growth
FedEx's opening of the most advanced internal distribution center in Mexico City was a surprise to some. However, it shows the company's commitment to growing in other key areas around the globe, such as China, Brazil, Mexico, India, the UK, Hungary, and Poland. International growth has more than doubled, from $653 million in 2011 to $1.4 billion at the close of 2014. The company's clear focus on growing internationally should position the company well for increased population and GDP growth abroad.
Image source: FedEx company presentation.
In addition, e-commerce growth should give FedEx a long wave of demand growth for shipping. The year-over-year growth rate of U.S. online sales versus retail sales is over 3 to 1. FedEx is well positioned to take advantage of this growth, and I don't see it dissipating anytime soon as more companies break away from traditional brick-and-mortar models.
Image source: FedEx company presentation.
Population and GDP growth around the globe position FDX well over the long term through increased product demand. The high barriers to entry in the industry should allow the company to maintain or even build market share, compounding investor returns over the long term.
A shareholder-friendly, competent management team with plenty of incentive
Since 1971, co-founder and CEO Fred Smith has led this $36 billion global transportation company. And he has plenty of incentive to operate in a shareholder-friendly manner, because he owns 5.58% of the shares outstanding. The company has proved itself to be incredibly shareholder-friendly in the past, returning capital of about $7.46 billion to shareholders mainly in the form of share buybacks since 2011.
Image source: FedEx company presentation.
What it means for FedEx
With its forward P/E at 10.82, you're paying below a market multiple for a business that has true competitive advantages. The FCF yield is 2.81% (based on three-year average free cash flow), the EV/EBIT ratio is 19.16, and the dividend yield is 0.72%. Even with shares off more than 25% over the past 12 months, the company appears to be moderately overvalued, but it's not every day you find businesses with great moats like FedEx off 25% from recent highs. Its competitive position and commitment to international and e-commerce demand should give investors a unique opportunity for years to come if the stock is purchased at the right price.
Foolish investors with the ability to look past current business weakness should welcome the pullback as an opportunity to look closer at the company. I'll wait for a larger margin of safety before jumping in the water, but I'll be watching.
