Saturday, August 06, 2005

FEDEX is a buy according to Barron's?

Barron's ran a very positive article on FEDEX this weekend. Let me first say that I have a short position on this stock and why I disagree with the assessment.

Barron's first said that the stock is down 16% and it's because of high fuel cost, higher capex and higher competition that weighed down the price.
The crude oil to fedex stock relationship just does not hold water. Why? If this argument will hold water, the negative correlation between the 2 factors will be consistent throughout history. During 2004, while oil was up 100% from $30 to $60, FDX went up by 35%. Immediately, you know that this relationship is not true. In addition, fuel surcharge imposed by FDX is having a positive on their P&L, so again this statement of higher fuel prices causing stock price to head down is downright misleading.

Costs did go up significantly, and that's not just fuel cost. That was the reason margins got crimped despite price increases (which was imposed almost across the board). Now, FDX is a cyclical growth stock, i.e., their cyclicality may not entirely depend on the economy as they do have strong international growth as correctly pointed out by the paper. Having said that, majority of their business is still cyclical and will be at the mercy of the U.S. economy (or global economy for that matter). The key to trading cyclical stocks is to watch margins, when they peak and trend down despite positive revenue growth, time to go. This is the part in which growth manager will overstay their welcome in the stocks.

Capex going up while margins continue to trend will spell trouble if and when things did not turn their way in 2006. That will significantly impact free cash flow and ROE if revenue start to turn down and they can't turn down the cost faucet fast enough.

The international growth story is by far the most telling part of the turning point in FDX. Why? Because typically when a company with significant portion of their business based in the U.S. suddenly EMPHASIZE their international growth proposition, especially having to spend to get there, you know that their are trying to distract investors attention away from the core business and justify slowing U.S. growth with higher international growth (smaller impact on EBITDA but look at the growth rate) in order to justify HIGH valuation. I just don't buy the argument that median of 16x is a bargain. Usage of 5 year median p/e is too short, especially using an expensive stock compared to an even more expensive S&P is a relative valuation game played in 2000 when analyst can't justify the multiples anymore but to compared against even more expensive metric.

There are other issues which I'm not going to go but I'll point out another critical point. Option expensing,if taken into account will crimp EPS this year by 2.5%. For a stock growing at low double digits, how much multiple contraction would we get, another 2-4x?

The paper's assumption of continued growth is flawed and the assumption that p/e will continue to expand is hope. The stock market is a discounting machine, just as it was discounting good 05 earnings during 2004, it well signal that growth is slowing going forward (see my Newspaper Media stocks comment lower). In additional, this stock still tout 75% institutional holding (50% would be consider unloved and worth a look) and put/call ratio and short interest are both low as well. Buy more folks and I'll borrow yours to short.


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