Summary
We do not know if Pershing Square is planning to invest in FDX, but many of the characteristics described appear to be a solid fit. FDX trades at a meaningful discount to UPS, despite having a more impressive franchise in many ways. In concept, FDX offers a simple service and competes in an industry with very high barriers to entry. The company’s topline is fairly predictable and FDX could generate substantial free cash flow if it ramped down capital spending (perhaps an issue for activism). The market cap is right, too. If Ackman is not buying FDX, he should take a look. The move in FDX shares today may be indicating just that – FDX matches his investment criteria well.
To review the opportunity at FDX, see our black book call here and write-up here. We have also had expert calls on independent contracting at FedEx Ground and on FedEx’s relationship with an evolving USPS. After all, if DHL can match competitor margins, FDX certainly can. In short, we think FDX is one of the best long-term opportunities in the sector.
Timing Matters
10-K Filing: FDX is scheduled to release its 10-K around July 15th. That matches the commitment timing for the Pershing investor commitments of July 17th. Reviewing the data released in the 10-K would be important before taking a concentrated, long-term position.
FY 4Q Express Margin: As we expected and noted, FedEx delivered on its goal to improve the Express division margin in its FY4Q 2013 earnings release. Gains should continue into FY2014 and FY2015 as the restructuring continues. It is less risky to commit after the company has already made headway on a critical restructuring.
Upside in Restructuring
Revaluation Potential: FDX matches peer margins in its Express division, we estimate that there is >50% upside in the shares (best case valuation of ~180, base case of 120-150, and a favorable sum of the parts approach). FDX has already started to generate improvements as of FY4Q 2013 results. There is no point in activism without the potential to unlock value and even following today’s move, FDX has that potential in abundance.
Expectations Low: FDX seems broadly misunderstood, with some analysts holding funny ideas about networks, leverage and contracts. Investors have trouble trusting FDX and an activist might help with that. Intentionally (in our view) weak guidance in the FY4Q earnings release has kept FY14 expectations for FDX very low relative to recent results. If Ackman could just get management to guide less conservatively, there could be significant upside.
Activism at FDX?
Unwelcome, but Likely Useful: We are not sure that activism at FDX will be especially welcome, but outside scrutiny of the Express segment restructuring is positive for shareholders. FedEx can be a bit insular and may not pay enough attention to the wishes of shareholders (e.g. FY3Q earnings were a tough comp because of a previously undisclosed insurance reserve reversal at FedEx Ground in the prior period – that is not helpful).
If He Isn’t, He Should
Ackman should buy a stake in FDX. The move in the shares today should make that clear.
P.S. BGG Could Use Some Activism, Too
In the event Mr. Ackman receives this, Briggs and Stratton should sell its Products segment. Even declaring it a discontinued operation could make the shares pop, we think.
