Baird-fedex-smartpost-4-15

8/6/2019 Baird-fedex-smartpost-4-15

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FedEx Corporation (FDX)

Takeaways from Recent Management Meetings and SmartPost Field Trip

Price: (4/15/10) 95.62 Rating: Neutral52WK H-L: 98 - 49Market Ca p (mil): 30,072.49 Suita bility: Avera ge RiskShares Out (mil): 314.5Float (mil): 292.2

Avg. Daily Vol (mil): 3.19

Price Target: 100Dividend 0.44Yield (%) 0.46

FY May 2009A 2010E 2011EQ1 1.23A 0.58A 1.01EQ2 1.58A 1.10A 1.34EQ3 0.31A 0.76A 1.10EQ4 0.64A 1.32E 1.64E

Total 3.76A 3.76E 5.10EFY P/E 25.4 25.4 18.7

EPS (Cal) 2.79E 4.45E 5.53EP/E (Cal) 34.3 21.5 17.3

Please refer to Appendix - Important Disclosures and AnalystCertification.

Jon A. Langenfeld, CFA

[email protected]

Benjamin J. Hartford, CFA

[email protected]

Action

Recent management meetings reinforced constructive view on integrators.Encouragingly, FDX commentary focused on pricing improvement throughout theplatform. FDX well positioned to benefit from an improving economy. The primarypotential sentiment near-term headwind, in our view, is the reemergence of costs tosupport the cyclical recover, which could temper F11 guidance.

Summary We recently hosted investors meetings and a tour of FedEx's Smartpost facility with

IR and Ground CEO David Rebohlz. Below we highlight our takeaways: Pricing focus remains a top priority. FedEx articulated its focus on balancing

volume and pricing to effectuate a healthier pricing environment. As volume andweight per package recover, we are encouraged by pricing growth commentary fromboth UPS and FDX.

International capabilities continue to expand. FDX growing a more compellinginternational priority product through a number of international initiatives, includingdevelopment of domestic international services (China, Canada, Mexico, India, UK).Within Europe, FedEx still lacks the scale of competitors, but management feelscomfortable with its organic growth prospects, using acquisitions where theopportunities are presented.

Costs will dampen near-term growth rate. Incentive comp, 401(k), pension andincreased maintenance/operating expenses all serve as headwinds for 2011. Thesecollectively could impact F11 over $500 million compared to F10. These are costsnecessary to support the strong volume growth, but may dampen F11 guidance, inour view.

Smartpost tour provides a deeper understanding of FDX's fastest-growingbusiness. Smartpost, FedEx's lightweight ground residential shipping solution,continues to take share through its low-cost delivery solution. FedEx has a completeUS network, strong growth performance (31% five-year volume CAGR) and

expanded service offering (international and returns offerings). While a small part oftotal revenue (6% of Ground,


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Details

A Closer Look at SmartPostIn 2004, FedEx purchased Parcel Direct, a leading small parcel consolidator for $122million in cash. The offering provided FDX with a service offering that targets lightweigh

residential delivery. FedEx rebranded the business as FedEx Smartpost and more thandoubled the network size. Over the last five year, Smartpost volumes grew at a 31%CAGR, the fastest-growing part of FedEx. In F10, we estimate revenue will grow 23%, inpart aided by the demise of DHL in the US.

Focused on lightweight, business-to-consumer packages. Smartpost operates 2primary hubs where parcels are gathered from FDX drivers or dropped off directly bshippers. FDX processes the shipments through its the Smartpost network. At the end othe network, FDX uses the US Postal Service for the final mile delivery, leveraging USPSparcel price breaks by delivering palletized parcels directly to the local post office closer tothe customer. Over 90% of parcels are routed directly to one of 16,000 local post officesused by Smartpost, the remaining parcels are routed to a USPS bulk mail centers primarilybecause density is not available to justify direct shipment to the local post office. Binserting the parcels into the USPS, FDX avoids the most costly part of the transaction -

home delivery.

Source: Company data

Lower-yielding, lower-service product for cost-conscious B2C shippers. Averagegross price of Smartpost parcels is $3, of which approximately half is the purchasetransportation cost paid to USPS for final mile delivery. This compares to average Groundparcel of $7/package and average Express box of $19/package. Lower average grossprice is attributable to lower package weight (typically 1-10lbs., capped at 20lbs.), no

delivery guarantee (avoids investing in peak volume capacity), and longer transit time.Smartpost parcels typically deliver in 3-8 days, while traditional FDX ground delivers in 1-5days and Express delivers in 1-2 days. Most importantly, this service offering fits intothe overall portfolio of service offerings provided to shippers.

FedEx CorporationApril 15, 2010

Robert W. Baird & Co.


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Source: Company data, Baird estimates

500

1000

1500

2000

96

97

98

99

Volume(000

)

%O

n-TimeSer

vice

SmartPost Service Improving with Density

On-Time Performance (Mnthly) Smartpost Volumes (Qrtly)

Will SmartPost Cannibalize Traditional Ground Business? We believe the shoranswer is no, because the product is strictly limited to residential deliveries and only folightweight packages. For example, major customers include online retailers. In its currenform, the USPS is not set up to handle heavyweight or larger packages; nor is it designedfor parcel consolidation in the B2B market. We suspect that over the past several yearsSmartPost has benefited from the trade-down effect of Ground customers moving to lowelevel of service at a lower price point. However, management estimates that 70-80% otheir volume growth was share gains from competitors including the USPS.

Overtime, it is critical to monitor anything that could accelerate the trade-doweffect from Ground to SmartPost. Because although the profit margin of the two

offerings are similar, the margin dollars are significantly different given the differential inthe price point ($7 for a Ground package versus $3 for a SmartPost package.

Investment ThesisCurrent thoughts. Recent results reflect an improving global freight environment withdemand across the business segments improving. FedEx's ability to effectively navigatethe downturn preserved the company's capabilities and longer-term earnings power.Significant costs were removed during the past 18 months (near $3 billion). So, investorswill be focused over the next few quarters on how fast and how much of these costs willreturn to the business. As a result, the magnitude of upward earnings revisions may be

buffered by incremental costs. Near-term outlook remains favorable and we believe thecurrent valuation reflects a balanced risk/reward, so we maintain our Neutral rating.

Diverse suite of leading transportation services. Recognized as the leader in globalexpress delivery, FedEx reaches over 90% of the world's GDP in 48 hours. After largelycompleting a worldwide express network in 1997, FedEx successfully diversified itsservice offerings. FedEx now operates the second-largest domestic ground packagedelivery network, the largest regional less-than-truckload provider, and a leadingdocument services company. This portfolio should enable FDX to deepen existing clientrelationships, expand its client base, and achieve market-leading growth rates.




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Express trends critical to capital returns. Long term, we expect express globalpackage volume growth to exceed GDP growth as the parcel market become a greatershare of transportation spending in Asia, Europe, and the US. Growth of the Expressbusiness is a critical component to sustain FDX's recent success improving margins andcapital returns. FDX must continue to work Express margins higher through growth andproductivity improvements. Every 100 bps of Express margin equates to roughly $0.50 in

EPS. While the current economic environment will limit margin expansion, over time weexpect the Express margin to improve 50-100 bps annually in a healthy economy.Express performance is essential to improving FDX's modest returns on capital (average10% ROC).

Sustainable leadership position in attractive markets. Global air cargo volume shouldincrease 5-6% annually over the long term. Industry leaders are benefiting from a numberof powerful trends including increases in globalization, supply chain complexity, anddemand for integrated logistics offerings accompanied by robust technology solutions. Inour view, few can match FedEx's scale and infrastructure, positioning the company toenjoy long-term leadership in global transportation and logistics.

Share gains in Ground; opportunity in Freight. FedEx is taking market share in thedomestic ground package markets with FedEx Ground, and we expect Ground to

continue to deliver above-market growth rates as the company further leverages itsdomestic and global capabilities. Additionally, FedEx Freight competes in the moreattractive regional LTL market. And though the company has struggled to integrate itsrecent acquisition of Watkins into its LTL offering amid the trucking freight recession, weexpect its combined LTL offering to capture market share over the longer term byleveraging its service-sensitive, low-cost model. This success should further diversifyFDX's business and improve overall company capital returns.

Valuation. Our $100 price target reflects roughly 17x our forward EPS estimates, oneyear out, above its average multiple given an improving earnings outlook. FDX's averagemultiple on forward estimates since 1999 is over 16x. Above-average multiple consistentwith near-term earnings near the trough of the cycle. In a better economy, we recognizethe potential for FDX to achieve sustained multiple expansion with an improving cyclicalmargin story and rising estimates.

Risks & CaveatsEconomic sensitivity. Impediments to economic growth or trade will negatively affectgrowth and profitability. As an asset-intensive business, small changes in revenue cancreate significant changes in operating profit.Domestic express market. Growth potential is constrained in FDX's largest segmentDomestic Express due to the increasing reliability of time-definite Ground alternatives.Further, rising fuel surcharges make the Domestic Express offering less pricecompetitive.Ground independent contractor model being contested by the IRS and through driverlawsuits. Unsuccessfully defending this model could negatively impact Ground

profitability.Competes in highly competitive markets. Global transportation and logistics is highlycompetitive and may be subject to price competition and deteriorating profitability.Capital returns need to improve. FedEx's return on capital has historically been belowits cost of capital. Recent success has resulted in double-digit ROC, but there are notguarantees these levels are sustainable.




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Company DescriptionFedEx Corporation is a $33 billion leading provider of global transportation and logisticsservices. Founded as a domestic air express company, management expanded

geographic and service coverage over the past two decades through organic andacquisition growth. Operates through four primary operating companies. FedEx Express - Largest express carrier and largest cargo airline in world; offers

variety of time-definite express services within one to three days and serving marketsthat comprise more than 90% of the world's GDP; segment includes Trade Networks, acustoms broker, freight forwarder division, and SupplyChain Systems, a logisticsservice.

FedEx Ground - North America's second-largest small-package delivery provider;Home Delivery targets business-to-consumer transactions; nationwide coverage; alsoincludes SmartPost.

FedEx Freight - Largest regional less-than-truckload (LTL); entered national LTLmarket through Watkins Motor Lines acquisition (subsequently re-branded FedExNational LTL); partnerships in Europe, Canada, Central and South America to provideinternational door-to-door coverage; includes Custom Critical.

FedEx Services - Responsible for sales, marketing and customer-facing informationtechnology. Segment includes FedEx Office (formerly Kinko's), the world's largestprovider of document solutions and business services with 1,800 locations worldwide(over 135 internationally) providing copying, printing, remote access solutions, andoutsourced document management services.




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Appendix - Important Disclosures and Analyst Certification

Q1 Q2 Q3 Q1 Q2 Q3 Q1 Q2 Q3 Q1 Q220

40

60

80

100

120

2008 2009 2010

06/01/07O:$125

11/16/07N:$108

12/20/07N:$105

01/04/08N:$100

03/20/08N:$98

06/18/08N:$90

09/18/08N:$92

11/10/08N:$70

12/09/08N:$65

03/09/09N:$41

03/19/09N:$50

06/17/09N:$59

09/11/09N:$79

09/18/09N:$82

12/08/09N:$93

03/08/10N:$97

03/18/10N:$100

Rating and Price Target History for: FedEx Corporation (FDX) as of 04-15-2010

Created by BlueMatrix

1 Robert W. Baird & Co. maintains a trading market in the securities of FDX.

Robert W. Baird & Co. and/or its affiliates expect to receive or intend to seek investment banking relatedcompensation from the company or companies mentioned in this report within the next three months.Investment Ratings: Outperform (O) - Expected to outperform on a total return, risk-adjusted basis the broaderU.S. equity market over the next 12 months. Neutral (N) - Expected to perform in line with the broader U.S. equitymarket over the next 12 months. Underperform (U) - Expected to underperform on a total return, risk-adjustedbasis the broader U.S. equity market over the next 12 months.Risk Ratings: L - Lower Risk - Higher-quality companies for investors seeking capital appreciation or income withan emphasis on safety. Company characteristics may include: stable earnings, conservative balance sheets, and anestablished history of revenue and earnings. A - Average Risk - Growth situations for investors seeking capitalappreciation with an emphasis on safety. Company characteristics may include: moderate volatility, modestbalance-sheet leverage, and stable patterns of revenue and earnings. H - Higher Risk - Higher-growth situationsappropriate for investors seeking capital appreciation with the acceptance of risk. Company characteristics mayinclude: higher balance-sheet leverage, dynamic business environments, and higher levels of earnings and pricevolatility. S - Speculative Risk - High-growth situations appropriate only for investors willing to accept a highdegree of volatility and risk. Company characteristics may include: unpredictable earnings, small capitalization,aggressive growth strategies, rapidly changing market dynamics, high leverage, extreme price volatility andunknown competitive challenges.Valuation, Ratings and Risks. The recommendation and price target contained within this report are based on atime horizon of 12 months but there is no guarantee the objective will be achieved within the specified time horizon.Price targets are determined by a subjective review of fundamental and/or quantitative factors of the issuer, itsindustry, and the security type. A variety of methods may be used to determine the value of a security including, butnot limited to, discounted cash flow, earnings multiples, peer group comparisons, and sum of the parts. Overallmarket risk, interest rate risk, and general economic risks impact all securities. Specific information regarding the

price target and recommendation is provided in the text of our most recent research report.Distribution of Investment Ratings. As of March 31, 2010, Baird U.S. Equity Research covered 613 companies,with 47% rated Outperform/Buy, 50% rated Neutral/Hold and 3% rated Underperform/Sell. Within these ratingcategories, 11% of Outperform/Buy-rated, and 7% of Neutral/Hold-rated, and 12% of Underperform/Sell-ratedcompanies have compensated Baird for investment banking services in the past 12 months and/or Baird managedor co-managed a public offering of securities for these companies in the past 12 months.Analyst Compensation. Analyst compensation is based on: 1) The correlation between the analyst'srecommendations and stock price performance; 2) Ratings and direct feedback from our investing clients, our salesforce and from independent rating services; and 3) The analyst's productivity, including the quality of the analyst'sresearch and the analyst's contribution to the growth and development of our overall research effort. This




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compensation criteria and actual compensation is reviewed and approved on an annual basis by Baird's ResearchOversight Committee. Analyst compensation is derived from all revenue sources of the firm, including revenuesfrom investment banking. Baird does not compensate research analysts based on specific investment bankingtransactions.A complete listing of all companies covered by Baird U.S. Equity Research and applicable researchdisclosures can be accessed athttp://www.rwbaird.com/research-insights/research/coverage/research-disclosure.aspx .

You can also call 1-800-792-2473 or write: Robert W. Baird & Co., Equity Research, 24th Floor, 777 E. WisconsinAvenue, Milwaukee, WI 53202.Analyst Certification. The senior research analyst(s) certifies that the views expressed in this research reportand/or financial model accurately reflect such senior analyst's personal views about the subject securities or issuersand that no part of his or her compensation was, is, or will be directly or indirectly related to the specificrecommendations or views contained in the research report.DisclaimersBaird prohibits analysts from owning stock in companies they cover.This is not a complete analysis of every material fact regarding any company, industry or security. The opinionsexpressed here reflect our judgment at this date and are subject to change. The information has been obtained fromsources we consider to be reliable, but we cannot guarantee the accuracy.ADDITIONAL INFORMATION ON COMPANIES MENTIONED HEREIN IS AVAILABLE UPON REQUESTThe Dow Jones Industrial Average, S&P 500, S&P 400 and Russell 2000 are unmanaged common stock indicesused to measure and report performance of various sectors of the stock market; direct investment in indices is not

available.Baird is exempt from the requirement to hold an Australian financial services license. Baird is regulated by theUnited States Securities and Exchange Commission, FINRA, and various other self-regulatory organizations andthose laws and regulations may differ from Australian laws. This report has been prepared in accordance with thelaws and regulations governing United States broker-dealers and not Australian laws.Copyright 2010 Robert W. Baird & Co. IncorporatedOther DisclosuresUK disclosure requirements for the purpose of distributing this research into the UK and other countries for whichRobert W. Baird Limited holds an ISD passport.This report is for distribution into the United Kingdom only to persons who fall within Article 19 or Article 49(2) of theFinancial Services and Markets Act 2000 (financial promotion) order 2001 being persons who are investmentprofessionals and may not be distributed to private clients. Issued in the United Kingdom by Robert W. BairdLimited, which has offices at Mint House 77 Mansell Street, London, E1 8AF, and is a company authorized andregulated by the Financial Services Authority. For the purposes of the Financial Services Authority requirements,

this investment research report is classified as objective.Robert W. Baird Limited ("RWBL") is exempt from the requirement to hold an Australian financial services license.RWBL is regulated by the Financial Services Authority ("FSA") under UK laws and those laws may differ from

Australian laws. This document has been prepared in accordance with FSA requirements and not Australian laws.

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