Tire City Case Report

FIN 439.001

Towson University
Group E:
Brandon Blake
Michael Gibbs
Gary Gutierrez
Xuan Li
Ben McCarty
Morgan Robinson

September 17, 2015

Recommend Buying FedEx Stock

Based on our analysis, we recommend FedEx (FDX) as a buy stock. We reached this conclusion
because FDX has a positive future outlook in a growing industry with an established competitive
position, high growth potential, strong financial metrics, and a promising valuation. Based on
these findings, our analysis indicates FedExs stock price is currently undervalued and there are
tremendous opportunities for stock price increases. In part, these opportunities hinge on FedExs
airfreight competitive advantage in the marketplace.
FedEx Provides Sought After Products and AirFreight Competitive Advantage
FedEx is a global shipping and solutions corporation that provides services to consumers and
businesses worldwide. Despite the cyclical nature of their industry, FedEx operations and
expansion strategies put FDX in a unique position to capitalize on the growth opportunities of
the industry. FDX operates in four segments: FedEx Express, FedEx Ground, FedEx Freight, and
FedEx Services. These segments provide service to a large audience, such as consumer
shipments, corporate shipments, and freight shipments. FedEx primarily operates in Canada and
the United States; through an acquisition, FedEx has expanded into South Africa and six other
countries. These operating segments and expansion strategies cement FedEx as an industry
leader because of its wide reach to target consumers.
FedEx focuses on airfreight as the companys main competitive advantage. This focus allows
FedEx to capitalize on the continually globalizing business environment. This is especially true
as e-commerce continues to evolve, rapidly links world economies, and faster delivery times
become expected. As world economies grow interconnected, FedEx is in a strong competitive
position to become the world leader in shipping goods and products around the world.
Strong Shipping Industry Outlook and FedExs Competitive Standing
The United Parcel Service (UPS) is FedExs primary competition. Like FedEx, UPS is a
packaged delivery company that delivers to over 220 countries and territories. UPS has three
market segments: U.S. Domestic Package, International Package, and Supply Chain and Freight.
UPS serves the global market for logistics services, which include transportation, distribution,
forwarding, ground, ocean, and airfreight.
Unlike FedEx, UPS focuses on ground shipments rather than airfreight. Therefore, it is important
to distinguish that the two companies serve the same industry, the shipment industry, but have
two very different industry niches, ground and airfreight respectively.
Currently, UPS holds a majority market share of about 46-50% in the U.S. market. However,
largely due to the airfreight competitive advantage, FedEx holds about 49% of express shipment
market share. Thus, it is important to note that FedEx is successfully capturing consumers that
are looking for expedited delivery. This market will continue to grow as e-commerce continually
rises in popularity. In addition, it will be very difficult for a competitor to capture this market due
to the large capital investment in air delivery mediums such as jets and cargo planes. Therefore,
FDX has tremendous potential in a growing industry and in an established industry niche.

Industry Comparables Show FedEx is in a Growth State

Compared to industry metrics, FedEx has a fair valuation. Since 2010, FedEx has maintained a
high price to earnings ratio compared to the industry and their main competitor, UPS. FedExs
price to earnings ratio declined from 2013-2014, but increased from 2014-2015, surpassing UPS
from 2013 onward. A high price to earnings ratio is usually found in companies with high growth
potential as investors are expecting high growth in the future. FedExs impressive price to
earnings ratio compared to the industry displays the growth potential FedEx possesses especially
compared to a maturing company like UPS.
However, because the price to earnings ratio is calculated using net income, the ratio can lack
nonrecurring earnings and capital structure. Price to operating profit includes those streams of
inflow and outflows to the company, providing another insight. FedExs price to operating profit
ratio declined from 2013 to 2014, but increased from 2014 to 2015 more than doubling their
2013 level. This shows FedExs strengthening financial position and yet more indications of
growth.
In addition, FedExs price to sales ratio has maintained and increased every year since 2012.
Using sales is more stable than using earnings because sales are never negative and are less
likely to have any issues with falsification. In 2012, their price-to-sale ratio was 0.68 and
increased to 1.02 in May 2015. Again, this trend shows FedEx as a growing and a financially
improving company.

______________________
FedEx vs UPS. (n.d.). Retrieved December 1, 2015, from
http://www.diffen.com/difference/FedEx_vs_UPS
High Growth Potential and Strengthening Historical Analysis Metrics

FedExs most glaring weakness is revenue growth volatility and revenue contraction. FedEx
reported revenues of $35.497 billion in 2009, down 6.47% from $37.953 billion in 2008.
Additionally in 2009, gross profit fell 11.2% to $9.058 billion while net income plummeted
91.3% to just $98 million. FedExs revenue growth and revenue growth volatility can be seen in
the chart below.

Despite this volatility and major contraction in 2009, FedEx Company has managed to recover
well in future years. Revenue increased by 13.16% in 2011 and has continued on the positive
since 2011. In addition, FDXs revenue growth has outpaced UPS in all years since 2011 except
in 2014. This shows that FedEx is in a growth position relative to UPS, its major competitor and
the largest market share holder in the shipping industry. This growth is reflected in FedExs stock
price performance.

FedExs stock price has continued to climb since January 2013. Despite a recent fall in late 2015,
the current stock price for the company still stands well higher than the historical average as seen
in the chart below.

In addition to revenue growth, FedExs commitment to increasing free cash flows helps to fuel
FDXs stock price performance. Since 2010 when the company recorded a 0.93% free cash flow
as a percent of sales, FedEx has improved this metric to consistently record over 1.00% in each
of the following years. Free cash flows as a percent of sales reached a peak in 2013, when the
company recorded a mark of 2.96%. Since 2013, the company has recorded marks of 1.60% and
2.15% in 2014 and 2015 respectively. This trend shows FedExs commitment to having free
cash which can create opportunities to enhance shareholder value.

Despite strong revenue growth and the creation of opportunities to enhance shareholder value
through free cash flows, FedEx has struggled to generate return on invested capital compared to
UPS. Since 2006, FedEx has fallen well short of the return on invested capital metric recorded by
UPS. This trend can be seen in the chart below.

In addition to falling short of the marks posted by UPS, FedEx has not been able to show an
increasing return on invested capital trend and the return has been volatile. However, FedExs
return on invested capital performance is highly correlated to revenue growth. For example, in
2011 and 2012 when FDX experienced high revenue growth, the company also posted strong
return on invested capital percentages relative to 2008-2010 marks. Therefore, as FedEx
continues to experience strong revenue growth, as our analysis figures it does, FedEx should be
able to improve and return a higher percentage on invested capital.
Healthy Cost of Capital Estimation
The capital structure of FedEx is currently 14% debt and 86% equity, which we feel is a healthy
balance. After calculating the total amount of debt FedEx carries and the weighted yields
associated with each issue we found the cost of debt to be slightly under 4%. Our capital asset
pricing model gives us a cost of equity 8.63%. Using these numbers we found the weighted
average cost of capital for FedEx to be at 7.76%. This number could be altered by adjusting the
risk free rate or the market risk premium, but we felt that 7.76% was an accurate number that
worked well in our discounted cash flow valuation.

Undervalued Stock Price shown in Valuation Estimation

When creating the final valuation for FedEx we used three different valuation techniques to fully
understand FedExs current price and develop a valuation range. The models we used include a

comparables valuation using only the P/E ratio, a comparables valuation using all relative
metrics, and the discounted cash flow method after finding the weighted average cost of capital.
Looking at the comparable valuation using only the P/E ratio, we found a range of prices from
$91 to $215 dollars with a most likely price of $123. This rather large range is due to the
competitors used in the valuation. To create a comparables valuation we used companies in
multiple shipping niches, which caused our valuation numbers to be slightly skewed. One of the
reasons we feel so strongly about purchasing FedEx is their lack of competitors in their specific
market, so these numbers did not greatly impact our final decision.
The story is similar when looking at the valuation including all relative metrics. The estimated
prices ranged from $72 to $182 with a most likely price of $115. These numbers are again a
misrepresentation of FedExs actual value.
The discounted cash flow method shows a price range of $190 to $430 with a most likely price
of $280. This is again a very wide range, but we feel this is the most important valuation for
FedEx. These numbers are highly dependent on the WACC, which we calculated to be at 7.76%.
A slight drop in this number could send the stock price through the roof, while a slight increase
still keeps FedExs estimated price above its current price of $152. Unlike the valuation models
that depend on other companies performance metrics, this is an in-house valuation using only
numbers taken from FedExs projected numbers. High growth projections for FedEx coupled
with their relatively low WACC produce a valuation that may be slightly higher than where the
price should be, but it still shows the potential for an increase in price in the future. This was a
key metric in our decision to buy FedEx.
After averaging all three valuation models we find a range from $118 to $276 with a most likely
price of $172. These valuations show that FedEx is currently undervalued by $20 and we feel
that this number is accurate. The low comparables valuations are balanced out by the high DCF
projections, giving us an accurate look at where we believe the price of FedEx should be.