Digging Deep at FedEx

FedEx has improved its return on equity over the last three years by boosting margins. However, cash flows from operations aren't increasing nearly as fast as net income and earnings per share, and the giant company's asset base keeps growing.

By Richard McCaffery (TMF Gibson)
September 19, 2000

Shares of express delivery company FedEx (NYSE: FDX) remained pretty much flat today after the Memphis giant reported fiscal first quarter sales of $4.8 billion, up 11% from last year, and net income of $169 million, up 6% from a year ago.

FedEx reported earnings of $0.58 per diluted share, up 12% from last year, and four cents better than analysts expected. A big chunk of the earnings boost came from the lower number of outstanding shares. The weighted average number of common shares is down about 4% from last year's first quarter.

FedEx is one gigantic company
It's easy to admire FedEx since it does so many things well: criss-crossing the globe to deliver packages on time, for example, or building a brand name associated with value worldwide, or fighting to improve margins in a tight-fisted business. In fact, FedEx's return on equity over the last three years is up about one percentage point, mainly due to margin improvements.

Problem is, there's nothing remarkable about a 15% return on equity. It's quite good for a capital-intensive logistics company, and it's important to note that it's trending in the right direction, but it's average when looking at the number of investment choices available today.

Stagnant cash flow, more debt than meets the eye
Consider that FedEx required $11.1 billion in average total assets last year to generate $688 million in net income and $1.6 billion in cash from operations -- which is pretty good, actually. But it's not enough to generate free cash flow due to the level of capital expenditures.

For the last three years, FedEx's free cash flow has stood, basically, at breakeven, and cash from operations has gone basically nowhere. Yet over the same period, total long-term debt is up 28% and average total assets are up 18%. Sure, earnings are up 37% over that period, but I'd like to see a commensurate jump in operating cash flow, and it just isn't there.

Also, when looking at companies like FedEx, remember that much of its financing isn't recorded on the balance sheet because of the way it structures leases.

You think FedEx, a company that operates 663 aircraft, really has just $1.8 billion in long-term debt? Many of its leases are structured as operating leases, which means the obligations aren't recorded as debt on the balance sheet.

Lots of airlines and retailers structure leases the same way, so FedEx isn't doing anything wrong or abnormal. But investors need to examine the section called lease commitments in the FedEx financials. At the end of last year, FedEx had over $14 billion in noncancelable operating lease commitments.

Regardless how the leases are structured, that debt is real, and servicing these obligations is part of the company's cost of doing business. (Lease payments appear on the income statement as expenses.) Keep that in mind when you're looking at the company's balance sheet.

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