Is FedEx an Ackman Pick?

Anh is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

FedEx (NYSE: FDX) has recently risen by 4.4% to more than $103.10 per share on the market, marking the company's biggest one-day gain since October last year. Since the beginning of the year, the company’s stock price has increased nearly 11.6%, lower than the S&P 500’s gain of more than 17.8%. The recent one-day gain was due to the rumor that activist investor Bill Ackman might initiate a long position in the company. The rumor is still just a rumor, though. The most important thing for investors to do now is to look at the business fundamentals and the potential of the company's performance in the future.

Does FedEx fit with Bill Ackman’s criteria?

Bill Ackman wrote that his fund, Pershing Square Capital Management, planned to invest as much as $1 billion in a large cap, investment-grade U.S. company, but he did not reveal the name yet. This business seems to have a wide moat, as its business is “simple, predictable, and free cash flow generative, and enjoys high barriers to entry, high customer switching costs and substantial pricing power.” However, several analysts argued that FedEx did not fit with Ackman’s criteria, as they thought it was not a simple business, it was not predictable, and it did not generate free cash flow.

In the past ten years, FedEx has consistently generated positive but fluctuating operating cash flow. Its free cash flow increased from $1.87 billion in 2003 to more than $4.83 billion in 2012. However, it has only consistently generated free cash flow since 2008. In the past twelve months, its operating cash flow was nearly $4.8 billion, while the free cash flow came in at $1.3 billion. The company also employed a reasonable amount of leverage in its operations. As of Feb. 2013 it had $16.1 billion in equity, $3.37 billion in cash and more than $2.24 billion in both long and short-term debt. FedEx also recorded more than $5.3 billion in pensions and other benefit obligations.

With the assumption of current fuel price outlook and $4 billion in capital expenditure, the company expected that it could experience a 7%-13% growth in its adjusted EPS. According to the company’s CFO, Alan Graf Jr., customers turn to lower-rate international services, driving down the pricing in the current market. Consequently, the company would decrease its capacity in two regions--the U.S. and Asia. At $103.10 per share, FedEx is worth nearly $32.9 billion on the market. The market values FedEx at around 5.6 times its trailing EBITDA. Its dividend yield is quite small, at only 0.6%.

The cheapest among its peers

FedEx has the cheapest valuation among its peers, including Deutsche Post (NASDAQOTH: DPSGY) and United Parcel Service (NYSE: UPS). Deutsche Post is trading at $26.30 per share, with the total market cap of $31.80 billion. The market values Deutsche Post at a much higher valuation, at 9.2 times its trailing EBITDA. The company has experienced good growth in several businesses, such as Express TDI, Forwarding/Freight, Supply Chain and Parcel Germany. Deutsche Post has grown its EBIT by nearly 3% to around $908 million, thanks to DHL Express business improvement. Deutsche Post expected that it could deliver as much as $3.55 billion to $3.88 billion in the full year EBIT. Deutsche Post would focus its efforts on improving its margin and generate more cash flow. The company also estimated that it could generate enough free cash flow to at least cover the 2012 dividend.

United Parcel Service is trading at $86.10 per share, with the total market cap of $81.30 billion. The market values the company at an extremely high valuation at 28.7 times its trailing EBITDA. Investors seem to be disappointed with the fact that the company’s management has cut its full-year guidance. Recently, UPS warned investors that its second quarter EPS could be around $1.13 per share, lower than analysts’ estimates of around $1.20 per share. It also reduced its full year EPS guidance, from $4.80-$5.06 to only $4.65-$4.85 per share. The sluggish outlook for the year was due to growing customer preference for lower-yielding shipping solutions, slower U.S. economy and slower in package volume growth due to labor negotiations. The company's dividend yield is much higher than FedEx's, at 2.8%. However, its payout ratio is not very encouraging, as it pays more than 2.5 times higher than its earnings in dividends.

My Foolish take

Among the three, FedEx is the best choice with the lowest valuation and consistently positive cash flow generation. However, I personally do not think that the business fits with Bill Ackman’s description of being simple, predictable, free cash generative with high customer switching costs and substantial pricing power. FedEx’s recent gain on the market is purely speculative, and I expect it will experience a downward correction when Bill Ackman announces his pick. 

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Anh HOANG has no position in any stocks mentioned. The Motley Fool recommends FedEx and United Parcel Service. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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