Can FedEx Deliver?

Over the last 10 years, shares of FedEx (FDX) have underperformed the S&P 500 and its competition, UPS  (UPS) . Can FedEx really deliver?

Year to date, shares of FedEx are up 6%. Over the last five years, shares are up 136%, but over the last 10 years, FedEx has underperformed, rising by 50%.

During the same 10-year period, Amazon (AMZN) shares are up over 1,900%. It would be a mistake to think FedEx benefits directly from Amazon's success. It doesn't. Amazon accounts for just 3% of FedEx revenue. FedEx's largest customer is the United States Post Office, which benefits from the growth at Amazon and from the growth of all of e-commerce websites.

The USPS delivers 50% of all e-commerce packages in the United States. Recently, the USPS aggressively raised prices by double digits on its small parcel delivery program. The postal service is expanding its capabilities to seven days a week, especially since the service believes customers want two-day delivery every day and not just on business days.

The postal service serves 156 million addresses six days a week and 70 million to 80 million on Sunday. The USPS expects e-commerce demand will increase 15% this year (on top of last year's 15% growth) and it plans to hire 35,000 people just for the holidays.

FedEx benefits in two ways. First, FedEx is the largest customer of the postal service, and the two keep finding ways to co-operate to save money. Secondly, the postal service has been increasing prices on the bottom end of it its package delivery service, giving FedEx more room to raise its prices.

Recently, the USPS has changed strategies. It has gone from chasing package volume by offering rock-bottom prices to offering more value-added services like last-mile delivery and Sunday delivery. With last-mile delivery, FedEx can carry package most of the way and then drop it off at the nearest post office. The post office then completes the last-mile delivery. By sharing the delivery, both carriers save lots of money. The USPS believes Americans are so addicted to online shopping they will suck up any price increases. For its part, UPS announced on June 1 that it would increase ground service rates and some air service rates an average of 4.9%, effective Dec. 26.

On June 21, FedEx reported fourth-quarter and full-year fiscal 2016 results. The company said earnings per share were $3.30, 2 cents better than the consensus estimate. Revenue rose 7.1% to $13 billion, vs. the $12.77 billion consensus.

The quarter was pretty solid, as three lines of business had improved revenue and operating margins. Express reported flat revenue of $6.72 billion vs, $6.70 billion last year, but adjusted operating income jumped 240 basis points to 11.3% as the company saw the benefits of improved yield management.

Ground revenue rose 20% to $4.29 billion. Operating margin dipped 160 basis points to 15.3%, as slightly higher operating costs took their toll.

Freight revenue rose 2% to $1.61 billion and operating margin was flat at 8.5%. Revenue was helped by less-than-truckload daily shipment growth of 8%.

The quarter benefited from an extra day, which helped to partially offset currency exchange rates and a decrease in fuel surcharges.

For the full year, fiscal 2016 revenue was $13 billion, up 7.4%. The company reported fully diluted earnings per share of $3.30, up 24%.

Investors were disappointed that management didn't say anything about the progress behind its acquisition of European shipper TNT. FedEx Europe has very high operating cost, and management believes it can lower those costs through the acquisition of TNT. The company has said it will spend $200 million integrating TNT into its business, including rebranding the company throughout Europe.

With the acquisition of TNT, fiscal 2017 revenue should grow 13%, and grow another 5% to 8% in 2018. Analysts are expecting operating earnings of $12.15 per share, a 12.5% increase over last year. They expect earnings per share of $13.54 the year after.

At just 13 times fiscal 2017 estimates, shares of FedEx are trading near a historic low. If the stock were to return to its average multiple of 16 times forward estimates, it could deliver a 23% return on a rise to $195.

This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.

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