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FedEx vs. UPS Charts

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Large-cap transport component FedEx ( FDX) is scheduled to report its second-quarter 2011 earnings Thursday morning before the bell, with analyst consensus expecting $9.7 billion in revenue and $1.31 in EPS for expected year-over-year sales growth of 13% and bottom-line growth of 39%.

For the short term, FedEx is being helped by improving volumes driven by a gradually strengthening economy, but over the longer term, another tailwind helping the company is the ability to raise rates (i.e., yields) that both FedEx and United Parcel Service ( UPS) have taken advantage of once DHL vacated the market.

The only headwinds to FedEx right now are the price of jet fuel (offset by the surcharge); pension expense, which has been boosted by very low interest rates; and FedEx Freight, which hasn't generated a consistent operating profit since mid 2008.

FedEx said that it would deliver 16 million packages on Monday, Dec. 13, which is the company's busiest day of the year. Unfortunately, the month of December falls in the February quarter, so we won't see the financial results until the company's next earnings release in late March 2011.

FedEx Express is the largest of the company's three segments, generating two-thirds of total revenue and about half of the operating profit (last quarter). Last quarter FedEx Express saw revenue increase 20% year over year, yields were 7.5%, domestic volume was up 2.5%, and Express's operating margin was 6%.

FedEx Ground has been a stellar performer for the company, now generating 20% of total revenue but 46% of operating income last quarter. Last quarter, Ground grew revenue 13% year over year, volumes grew 6.7%, and yields were up 5%.

The real driver to FedEx's earnings is operating leverage, and you can see it in the Ground unit with 13% revenue growth last quarter in Ground but 37% operating income growth. The ability to drive volume over relatively stable fixed-costs is really an earnings catalyst for the company, and the only thing better for FedEx at this point would be to see falling jet fuel prices as volumes rise. With DHL out of the U.S. market as of a few years ago, UPS and FedEx have kept the Ground rates rational in terms of competitive pricing, and until that changes, yields should continue to be mid single digits for both companies. The Holy Grail for FedEx is a total 10% operating margin, with a 6.6% result last quarter. The company almost made it in 2007 and 2008, but the mortgage and banking crisis took care of that.

With expected revenue growth of 13% but expected earnings growth of 39%, FedEx is nearing the sweet spot of the economic cycle, as continued volume growth is a plus, as long as costs can be kept relatively flat. For 2011, the company is expected to generate $38.9 billion in revenue and $5.21 in EPS -- these are current analyst consensus numbers -- for expected growth of 12% and 39%, respectively. The stock is trading at 18x 2011 EPS estimates and 15x 2012 EPS estimates. In addition, FedEx is trading at just about 10x cash from operations, although free cash flow has been negative the last few quarters, thanks to sharply higher capex.

FedEx has a number of positives going for it right now, although the management team is always very conservative in its guidance. We would be stronger buyers of the stock in the mid $80s, but the fundamental story is a compelling one right now.
At the time of publication, Gilmartin was long FedEx and UPS, although positions may change at any time.

Brian Gilmartin, CFA, founded Trinity Asset Management (TAM) in 1995, where he is currently a portfolio manager. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Gilmartin appreciates your feedback; click here to send him an email.

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