Transportation Stocks Offer Mixed Prospects
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Anyone with any lingering doubt that the European debt crisis isn't having an affect on global growth should take a look at FedEx Corporation's (NYSE: FDX) latest results. There is nothing dramatic happening, but it is subtle shifts in customer behavior that can make a marginal difference to a company's prospects. In the case of FedEx, European uncertainties and the moderation in growth in Asia are causing customers to shift from its premium services to its deferred products. In addition, the weaker than expected global growth has caused necessary adjustments in the way that the company does business.
In line with most forecasters, FedEx has lowered its global growth forecasts as the year has gone on. The interesting thing is that FedEx's forecasts have tended to be more accurate than the Federal Reserve's over the last few years, so they are well worth taking note of.
It is not only the quantum that has affected the company's growth prospects, but also the uncertainty around those factors. US GDP growth in 2012 is now expected to be at 2.2% with global growth forecast at 2.4%. Turning to 2013, US GDP growth is forecast to improve to 2.4%. As for the uncertainty, the company is seeing relative weakness in its Express segment (42% of operating income) with operating margins and packaging volumes declining in the quarter. This is partly a consequence of customers shifting to the more value orientated slower delivery services.
As such, FedEx has taken a $134 million impairment charge and retired 24 planes in order to better match expected volumes in the US domestic air network. Newer, more fuel efficient planes are being introduced and management believes that margins will improve in the future.
Whilst cost efficiencies are seen as driving growth at Express, the other two segments are seeing volume growth in line with economic growth. The Ground segment (50% of operating income) saw strongly improved margins and volumes improved as its value proposition came to the fore thanks to the weakening economic conditions. In addition, it is seeing some benefit from increased e-commerce revenues.
The smallest segment is Freight (8% of operating income) which saw margins improve due to higher yield and volume growth.
What FedEx Offers Investors
Essentially FedEx and its rival UPS (NYSE: UPS) offer a highly correlated GDP plus type investment proposition. These stocks offer a view to where global growth is headed. A fall in oil prices will obviously help reduce transportation costs, but if energy prices are falling due to weak end-demand, this implies that FedEx's top-line will weaken similarly. Ultimately, revenue growth will be dictated by a resumption to the Eurozone debt crisis and a successful implementation of China's stimulus efforts.
With regards the correlation of UPS and FedEx to the global economy, this can be shown with the following graph of global GDP growth versus UPS revenue growth over the last decade.
That said, the moderation in growth in Asia clearly caught FedEx by surprise as has the shift to slower, more value orientated shipment options. In addition there is a certain amount of lumpiness around orders in Asia from technology shipments from certain key customers. On a more positive note, the company has implemented a number of competitive measures and acquisitions in Europe which has seen it relatively outperform in a weakening market.
The one area that has proved problematic is the expansion of international Express services. Growth has been weaker than expected and it is hard to ascertain whether this is due to the economy or something intrinsic to non-US markets. No matter, FedEx has taken appropriate measures to scale back network expansion plans.
What Next For FedEx?
The stock remains a correlated play on the global economy. There are some secular growth drivers with things like increased e-commerce related shipment but I do not think the difference is marginal enough to change the basic investment proposition. Throw in a relatively low yield and this stock is really only attractive for investors with a lot of confidence in the global outlook.
In terms of which stocks might appear more interesting, given FedEx's results and commentary, the railroad companies are well worth a look. FedEx reported its highest margins in Freight since 2008. Therefore, companies like CSX or Norfolk Southern look set to be beneficiaries from a slow but steadily growing US economy. Although investors will have to keep an eye on their commodities freight demand because things like coal are seeing weakening demand.
Ultimately, the advantages that the railroad companies have is that railtrucks have become much more fuel efficient. For the railroads, this means that their value proposition is relatively enhanced in a high fuel cost environment. Throw in a slugghish economy and customers will be more willing to accept slower delivery if it comes at a discount.
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