Plugged in to the global economic heartbeat

In late July Fedex increased its earnings outlook for the year to May 31 2011, from $4.40 - 5.00 to $4.60 - $5.20 per share. The range is still quite wide and so management has a pretty big target to hit. Even so, over-zealous outlooks are not something that we are seeing at all in the post-GFC world. If anything companies are tending to adopt a cautious if not understandable “under-promise, over deliver” approach.

The upgrade is a firm tick for the global recovery, given that Fedex’s business is intimately linked with the level of economic activity around the world. The guidance upgrade occurred in late July and was based on the company’s experience up until then. Now with more than a month under the bridge, there is always the risk that activity has begun to tail off.

If those that believe that the US is heading for a second recession are correct, then we would certainly expect to see Fedex’s volumes coming under pressure. The company is scheduled to report its first quarter performance later this month. Management’s previously revised first quarter earnings guidance is for between $1.05 and $1.25 per share.

A key insight into the likely health of Fedex’s business is provided by global manufacturing data. There was some very good news on this front earlier in the week. The Institute for Supply Management revealed that its US factory activity index rose to 56.3 last month. Any reading above 50 is indicative of expansion and the move from 55.5 in July suggests that the pace of expansion has accelerated.

The US manufacturing sector has now been expanding for 13 months straight, which is exactly what we would expect to see during a recovery. It’s a similar story for the eurozone, the UK and China, albeit to varying degrees. We would therefore expect Fedex to have little difficulty in hitting its first quarter guidance.

The other aspect to consider with Fedex is that it is not just sitting back waiting for sales volumes to increase. The company carved out a significant amount of excess fat through the GFC and as a fitter leaner business it has greater leverage to the recovery. We expect to see higher margins drive a greater number of top line sales dollars through to the bottom line over the next few years.

Digging around recent data releases in the hunt for more Fedex relevant indicators, we found the American Trucking Association’s monthly tonnage report. The report simply aggregates freight tonnage across the US. The July data saw a reversal of the previous month’s decline, rising 1.5% on the month and up 7.4% from the same period last year. This is once again positive for Fedex and the health of the US economy more broadly.

From a valuation perspective, Fedex trades on around 15.8 times consensus 2011 earnings, falling to around 13.3 times consensus 2012 earnings. We view the stock’s valuation as undemanding given its growth potential over the next few years as conditions continue to normalise. We would also expect investor enthusiasm to build if management can deliver further margin improvement through the year ahead.

In other news, Fedex’s legal department has been busy of late dealing with a lawsuit lobbed at the company on behalf of a small group of current and ex Fedex truck drivers. The drivers are employed as contractors, which essentially grants Fedex greater flexibility in their employment and ultimately at a lower cost. The drivers view is that Fedex exerts sufficient control over them in terms of uniforms and work schedules that they should be considered as employees.

There doesn’t seem to be a high probability that Fedex will be forced to recognise these drivers as employees. A judge last week agreed that in his view the drivers are independent contractors and similar cases have previously failed. At any rate, legal wrangling of this nature takes many months to play out and even the worst case scenario for Fedex would not force a material adjustment to its valuation.

A potentially more serious issue is an allegation of fraud that has been levelled at Fedex from the New York Attorney General, Andrew Cuomo. Mr Cuomo has requested details on lawsuits or claims relating to high value items from the company. The implication is that Fedex may have committed some form of fraud in relation to the value of these claims.

There doesn’t appear to be anything substantial behind Mr Cuomo’s claims, but without knowing exactly on what they are based we will simply have to keep a close eye on any further developments. Fedex has predicably denied any wrong doing and is actually counter-suing Mr Cuomo, who according to Fedex doesn’t even have the authority to investigate the company.

Taking a look now at the weekly chart, we can see that the price action has dipped below both the 39 week and 200 week moving averages. This follows a break of the uptrend support earlier in the year. However, the recent reversal in the weekly MACD suggests a potential exhaustion of selling.

The daily chart reveals that the 50 day moving average has halted the recent decline. This move is confirmed by the new RSI uptrend that has formed since the oversold reading that corresponded with the July 1 low of $69.78. We would now target a break of the 200 day moving average which would then open up an upside target of $97.75. This corresponds to the 52 week high made in April.

In summary, Fedex is directly plugged in to the world’s economic heartbeat. This will see it flutter from time to time as investor sentiment ebbs and flows. In our view though, the prospect of a double dip US and potentially European recession is slim and our bullish view on the stock is unchanged.

We continue to recommend Fedex as a buy for Members without exposure around $81.72.