Top credit-rating agency Moody's (NYSE:MCO) has faced sharp criticism in recent years for its rosy projections and lax credit rating standards in the years before the 2008 financial crisis.

Many financial analysts have questioned Moody's entire business model, arguing that because it is paid by debt issuers to rate their bonds, the firm faces an insurmountable conflict of interest. It runs the risk of alienating a customer whenever it cuts a company's credit rating. This could give Moody's an unfortunate incentive to give some bonds higher ratings than they deserve.

Moody's doesn't seem to have a cozy relationship with FedEx (NYSE:FDX), though. Earlier this month Moody's cut its ratings for FedEx, which has been steadily expanding its debt burden recently -- and it offered even more words of caution about FedEx last week.

FedEx's debt load rises
FedEx has added lots of debt to its balance sheet in the past few years. For example, through the first three quarters of its 2016 fiscal year, FedEx has produced very little free cash flow. Of the company's $3.8 billion of operating cash flow, it reinvested more than 90%, spending nearly $3.6 billion on capex.

FedEx has been reinvesting most of its operating cash flow in recent years. Photo: The Motley Fool

Despite its minimal free cash flow production, FedEx spent more than $2 billion on share buybacks and paid out more than $200 million in dividends. As a result, it has drawn down its cash balance by nearly $1 billion while issuing another $1.2 billion of debt.

FedEx's debt load is about to get a lot bigger. Last year, FedEx announced plans to acquire European package delivery company TNT Express for nearly $5 billion of cash. FedEx expects the sale to close within the next few months. It had less than $3 billion in the bank as of the end of February, so it will need to issue new debt to cover most of the purchase price.

Finally, FedEx's board approved a new 25 million share repurchase program in January. It began working on this buyback program last quarter, and it will need to spend another $3 billion or more to complete the full authorization.

Moody's cuts its ratings for FedEx
Given that FedEx's spending plans seem to be vastly outstripping its cash flow, Moody's has described several events in the past year as "credit-negative" for FedEx. On March 15, it finally decided to cut FedEx's credit ratings by one notch, putting its senior unsecured rating at Baa2: the second-lowest rating that is still considered investment-grade.

While Moody's gives FedEx credit for successfully executing its profit improvement program over the past few years, it takes a dim view of the TNT Express purchase. Moody's noted that the acquisition will drag down FedEx's profit margin because TNT Express isn't very profitable. It also thinks that FedEx won't realize much in the way of synergies for the next few years.

On FedEx's recent earnings call, CFO Alan Graf stated that the company had expected the Moody's ratings downgrade. Meanwhile, CEO Fred Smith insisted on the earnings call that FedEx will generate enough cash flow to pay for annual capex of up to $5 billion while also paying down its debt from the TNT purchase and funding share buybacks.

FedEx gets another warning
Moody's is clearly skeptical about these claims. Earlier this week, it issued a follow-up report about FedEx that seems to imply that the company could face another credit rating downgrade within the next few years.

"'FedEx will likely have to tap the debt markets in order to sustain share repurchases over and above the couple hundred million [dollars] per year required to offset dilution from stock compensation plans,' said Jonathan Root, a Moody's Vice President and Senior Credit Officer. 'In addition, the synergies from the TNT acquisition will not provide the earnings growth necessary to offset the company's increased debt.'"

Moody's now projects that FedEx's debt/EBITDA ratio -- a key credit metric -- will be about 10% higher (worse) than the average for companies with the Baa2 rating. In the recent report, Root also speculated that the FedEx-TNT Express combination could provoke a competitive response from DHL and United Parcel Service. That could put more pressure on FedEx's profit margin.

It may turn out that the FedEx-TNT Express merger goes smoothly and FedEx's cash flow rises as much as the management team expects. If that happens, then Moody's will eventually raise FedEx's credit rating again. But for now, Moody's is providing an appropriate warning to investors that FedEx's aggressive financial strategy creates significant risks for bondholders.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.