FedEx Jumps on Upgrade

Merrill Lynch says the company's cost-cutting program is reaping rewards.
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FedEx

(FDX) - Get Report

shares hit a 52-week high Monday after Merrill Lynch upgraded the shipping company, telling investors that FedEx's cost-cutting program was reaping rewards.

Analyst Ken Hoexter raised FedEx to buy from neutral, set a new price target of $80 and boosted his fiscal 2004 and 2005 earnings estimates. A known bear on the shipping sector, Hoexter said he softened his stance because of better-than-expected cost reductions by FedEx -- which has an early retirement program in place -- and solid growth at its ground shipping unit.

"After the company announced a stronger take rate for its early retirement/severance programs ... we felt comfortable in the secular change at FedEx," said Hoexter, in a research note. "Aside from the cost cutting, which will help Express, the margin improvements should be significantly beneficial to the company's goal of increasing its cash flow margin, pay down debt, increase dividends and buy back stock."

In reaction to the analyst note, investors pushed FedEx shares higher on Monday. At midday, FedEx was up $2.51, or 3.7%, at $71.07, after hitting a 52-week-high of $71.25. Rival

UPS

(UPS) - Get Report

was up 53 cents, or 0.8%, at $66.65, also hitting a 52-week high.

With FedEx trading around 17 times projected 2005 earnings, Hoexter thinks shares could have even more upside, despite gaining 26.4% year-to-date as of Friday's close. Because of the cost cutting and growth in ground shipping, the analyst said that FedEx was on track to meet its goal of 8% operating margins in its Express business, calling this initiative "the key to the FedEx story."

But cost-cutting isn't the only reason to look at FedEx, in the analyst's view. Despite the fact that FedEx has lost some share in the ground shipping business to rival UPS, Hoexter said the company will be able to show at least upper single-digit growth in ground business, while continuing to take share from other rivals, like the U.S. Postal Service.

"Although we are lowering our ground average daily volume growth estimate to 3% from 10% for fiscal 2004, we are keeping our 7% growth estimate for fiscal 2005," said the analyst.

Ultimately, with a strong cost-cutting plan, solid returns from the ground business and growing margins in the express business, Hoexter said investors will benefit from more than just a rising stock price. They could also benefit from a rising dividend, which the company initiated at 5 cents a share just one year ago.

"With a mature core operation, improving corporate operating margin, strengthening free cash flow and the use of only $60 million annually for dividends, we believe this company will look to increase its dividend by as much as 10% for fiscal 2005," he wrote.