swot analysis federal express

Equity Research Transportation

IWANOWYCZ, KAYLO, LEE, SEKINE, & WELLS

CORNELL EQUITY RESEARCH December 5, 1999

Federal Express (NYSE:FDX) SELLTarget: $30“It is not going to happen overnight!”

Date: December 3, 1999

Current Price: $41 15/1652 week Price Range: $32 – 61 7/8

Dividend Yield: 0.0%Proforma LTD: $3.8 billion

Combined Market Cap: $12.2 billionPro-forma shares o/s: 298.6 millionShares Short at 9/08/99 8.88 millionShort Ratio 5.42 daysAverage Volume 2.0 millionFiscal Year End: May 31Institutional ownership: 65.25%

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Consensus Estimate 05/99A 05/00E 05/01E

EPS $2.10 $2.17 $2.52P/E 20.0x 19.3x 16.6x

Growth Rate: 12%12-Month Price Target: $30 (14 X FY00’ EPS)

Valuation

DCF Valuation: $48EBO Valuation: $22G-Model valuation: $43EVA Valuation: $42

FDX appears to be overvalued in comparison to the current stockmarket valuation.

Comparables Analysis: With respect to P/E ratio, Price to Sales,and Price to Cash Flow, FDX is overvalued in comparison toindustry averages.

mpany Description

X Corporation is a global transportation and logistics enterpriset offers customers a one-stop source for global shipping,istics and supply chain solutions through its subsidiaries FDX,S and others.

vestment Thesis

e outlook of FDX is at best uncertain. We believe that there areeats on all fronts:

E-Mail is reducing the amount of overnight packageactivitiesUnclear strategy to deploy FDX’s ground transportationdivisionLow single digit domestic growthInternational growth promising, but needs a successful trackrecordUnclear visibility into FDX’s execution strategy and productpipelineCurrent investments yielding lower than cost of capital



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Investment Thesis• E-Mail is reducing the amount of overnight package activitiesElectronic mail has become a popular method of transmitting personal information. We believe that suchtransformation will begin to emerge in commercial document delivery. Increasingly, commercialdocumentations will be sent electronically. This evolutionary shift in information delivery can potentiallyreduce the demand for the company’s core overnight products.

• Unclear strategy to deploy FDX’s ground transportation divisionUPS is the Godzilla of Ground Transport with a current market share over 75%. In addition, UPS has thedensity of labor and networks to deliver ‘business-to-residential’ products. FDX will need to significantlybuild brand recognition as a viable ground transportation competitor and build the labor force in order tomeasure up to the Godzilla of Ground Transport. In the near term, we expect that FDX may not achievemarket share improvements with this product. We foresee diminishing market share as UPS aggressivelypostures to maintain and improve its market share. Should there be significant improvements in this area,we may be inclined to review the existing recommendation.

• Low single digit domestic growthThe domestic market is currently viewed as mature and we expect market growth of 3 to 4% annually. Themarket is composed primarily of Priority and Standard overnight packages. Historical year-over-yeargrowth in FedEx domestic business has been, on average, 12%.

• International growth promising, but need successful track recordWe believe that both international sectors can now grow in tandem. As Asia continues to recover and thecompany deploys the new $200 million hub in Paris, we expect to see an enhancement of FedExinternational revenues. In the near future, we expect FedEx’s international revenue growth to be between15 and 20%. Although such expected growth figures are high, the related base volume is low.

• Unclear visibility into FDX’s execution strategy and product pipelineAlthough there are trademarked services and products in the pipeline, it is not clear that FDX has deployeda coherent business locomotive to deliver shareholder value.

• Current investments yielding lower than cost of capitalFDX’s weighted cost of capital (WACC) is approximately 8.5%. Assuming a return on invested capital(ROIC) in the 6.5% range, the company is not earning its cost of capital and, hence, firm value is beingdestroyed. In other words, no economic value is added through operations unless FDX improves itsprofitability.

Investment Summary

In light of our analysis and our bearish assessment of the company’s future revenue stream, we believe thathrough increasing efforts and costs, FDX will continue to build momentum to maintain its current level ofdomestic air and freight business. As much as we are cognizant of FDX’s improving business in Asia andit is expanding network deployment in Europe, we would like to observe concrete product developmentsand execution strategies before adjusting our estimates. Any of the following may be signals forimprovement:• Predictable revenue stream on all fronts with recurrent growth level above 12%• Visible synchronicity on all fronts: domestic and international• Adequate management guidance into the depth of its product development pipeline• Visible deployment of strategies through joint ventures and partnerships with ground transport

companies• Acquisition or joint venture deployments with Internet-enabled electronic documentation companies or

partners



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Table of Contents

I. Industry AnalysisIndustry Characteristics 4History 4Industry Outlook 5Market share Analysis 6Competitive Forces 6Challenges 7

II. FDX: A Company ProfileCompany Business and background 8Business Segments 8Management 9SWOT Analysis 10Brand Strength 10

II. Stock Price PerformanceOverview 11Volume and Price Momentum 12Relative Performance 12Insider Trading 12Institutional Ownership 13Short Interest 13

III. Financial AnalysisROE Decomposition 14Profitability 14Asset Efficiency Analysis 14Cash Flow Analysis 15Altman’s Z-score 15Liquidity and Solvency 16

IV. AccountingFinancial Position 17Review of Accounting Policies 17Beneish Test for Earnings Manipulation 18

V. ValuationCost of Capital and Cost of Equity Analysis 19Analysis of Expected Company Growth 19EBO Analysis & Sensitivities 19DCF and EVA Analysis 19Comparables Valuation 20StockVal G-Model 20

VI. Exhibits 21



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Industry Analysis

Industry Characteristics

Falling costs,increasing volume

Movementtowardsintegration ofground and airtransport

• The airfreight industry concentrates on the highest value, most time-sensitivemanufactured goods moving long distances. Historically, this has beendocuments, small packages, and cargo that require overnight delivery. As costshave fallen, this has opened the doors for an increase in lower value and heaviermanufactured goods to be shipped by airfreight.

• The air freight industry consists of carriers that are known as integrators, whologistically manage a network of air and ground transportation (e.g. trucks andairplanes) in order to deliver items door-to-door.

• Since FDX also competes in the second day ground services through anacquisition of RPS, the company must also be analyzed in the ground integratedground transportation segment. UPS is the dominant player in that segment.

• Heavy air cargo shipments tend to average between 200 and 300 pounds, or lessthan a typical LTL motor carriage shipment. Air express package shipments tendto average three to five pounds. The items weighing less than two pounds tend tobe documents.

• The line between ground and air transportation is blurring. It is difficult tocompare FDX to all competitors in the transportation sector due to the “door todoor” nature of the business. FDX competes in the “airline” sector as well as the“transportation – air freight” sector. Due to industry trends moving towards costcutting and the introduction of new, faster ground transportation services, FDXhas competitors in the ground transportation sector.

Even though certain analysts believe that a 7.4% improvement in profits can beachieved in 1999, it is not clear whether this pertains to the “door to door” sector ofthe air express industry. Since there will be downward pressure on the top linerevenues of integrators to switch to ground transportation, this could conceivably onlybe in the air freight segment and not extend to the air / integrator segment.

History

Largest venturecapital endeavorin history (at thattime)

Late 1960s Fred Smith, a Vietnam veteran, presented FDX’s business concept in a Yale term paper. He received a “C”.1969 – 1971 Smith raised $40 million in investor funds, $8 million in family

money & $90 million through financing1973 Service started to over 22 US cities with overnight delivery1974 UPS strike, competitor REA Express went bankrupt1978 UPS went public1986 UPS loses $300 million on Zapmail, satellite based network

providing 2-hour document delivery1987 FDX bought Island Courier Companies, Cansica, and three

Japanese freight carriers1988 FDX bought Tiger International for $880 million, doubling

overseas revenues and becoming the #1 air cargo company



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1991 FDX introduced EXPRESS freighter, an international air-expresscargo service

1992 FDX scrapped its loss-making European domestic pickup anddelivery service

1993 FDX pilots ‘rock the boat’ by announcing their decision tounionize; touching off protracted negotiations.

1994 FDX became the first US express carrier with direct flights toChina, and created Latin America and Caribbean divisions

1995 FDX introduced InterNetShip, a service allowing users to printtheir own shipping labels and communicate with recipients via e-mail, and a software package called BusinessLink, which allowsbusinesses to sell goods over the Internet

1997 FDX announced plans to create a hub at Charles de Gaulle Airportin Paris (its first hub in Europe) and another in Miami (to drive its expansion into Latin America).

Industry Outlook

Downward top-line growth:• Domestic growth is slowing. The airfreight portion of the transportation sector which includes

everything from lightweight packages to heavier manufactured goods, is entering a slower phasewithin a long-term secular boom. Results for the air freight portion of the transportation sector,including lightweight packages to heavier goods, is entering a slower short-term phase.

• Downward Pressure on the Air Express segment in favor of ground transport. New services, such asdeferred delivery and existing services offered by ground transport, are encroaching into FDX’s pieceof the pie. Also, within a 600 mile radius (the distance a truck can travel in a day), people are optingfor ground transportation, since the ground transportation companies are now guaranteeing delivery inas little as one day and as much as four days. The pricing of ground transportation is much morecompetitive than that of air. Further compounding this pressure on air express companies is the trendof suppliers and distribution centers locating hubs within the 600-mile radius to the more populatedretail centers.

Top-Line Growth:• Industry studies show “Long Term growth promising”. The long-term prognosis has promise, with

domestic airfreight expected to grow by 5.7% annually through 2002. (Reference: MergeGlobal,Arlington, VA). However, we believe growth will be around 2-3% on the conservative side. We wantto aggressively look to signals that may identify growth opportunities.

• New sources of Income. Outsourcing and inventory reduction efforts will create markets throughwhich suppliers’ ship to third parties who will manage inventory and then ship to the destination,creating a new shipping leg for product delivery. We believe that this will benefit the groundtransportation segment contrary to what the airfreight industry had touted.

Cost reduction:• Continued efficiency efforts. Investments in larger wide-body aircraft will lower the per unit costs

(could be as much as 15% depending on current aircraft mix, thereby opening the door for new classesof larger, heavier package transport.

Cost Increase Pressures:• Labor Issues. In the air freight industry, aircraft pilot wages represent 10% of total costs. The

industry faces constant pressure to improve labor wages, benefits and working conditions, while theexperiencing competition and profit margin pressure. The recent surge in the need for groundtransportation is being strained by a shortage in truck drivers, driving up trucking salaries. The



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constant threat of strikes is also a concern in the industry. UPS’ 15-day strike affected the company’srevenues and earnings significantly.

• Cost increases. All fleets must be upgraded to meet Stage Three noise standards, which willnecessitate upgrades to existing aircraft (estimated at $100 million in 1999) and/or retirement ofexisting planes and purchase of newer quiet engine planes.

Market Share Analysis

Defining the US Air Express market as Domestic Overnight and Domestic Deferred, the revenue for thetotal market is estimated to be approximately $34 billion. FDX derives 56% of their revenues from thismarket and UPS derives 29% of their revenues from this segment of the market. While we estimate thatFDX controls about 28% of the domestic express airfreight market by volume, UPS only controls about18%. Airborne maintains approximately 10%.

Airfreight accounts for $25 billion, which represented approximately 5.6% of the US commercial freighttransportation market in 1997. Of the $25 billion, $20 billion was from the movement of domestic freightand $5 billion was generated by US based air carriers through the movement of goods to or from the UnitedStates. The airfreight / air cargo industry consists of air carriers, forwarders, and passenger airlines thattransport freight as a by-product. In addition to the $25 billion above, an additional $15 billion wasgenerated by integrators and forwarders handling international cargo.

Domestic Ground, consisting of non-express packages, is considered to be a $17 billion market. UPScontrols about 75% of the market and RPS, which is a subsidiary of FDX, controls about 11% - 12%. UPSand RPS derive approximately 54% and 11%, respectively, of their revenues from this market.

Competitive Forces

Competitive Landscape:• Main Competitors. Federal Express is the largest integrated airfreight carrier, with domestic

revenues of $10.3 billion in 1997. UPS, which is the largest transportation. UPS, which is the largesttransportation company in the US, derives some $6.3 billion from domestic air freight/express services.While the industry can be characterized by two major players. Other important competitorsconstituting the competitive fringe are: Airborne Express, DHL Worldwide, and Emery Worldwide.

• On the International front. Freight forwarders dominate the international market. Even though somecompanies are integrators domestically, they are only forwarders internationally.

• Forwarders. There are approximately 2000 competitors, which are classified as forwarders. They donot own or lease aircraft and many do not own ground transportation either.

• Super-regional LTLs. Also, the local LTLs (less than truck load carriers) are banding together to formsuper regional partnerships that extend their ground delivery over larger areas with more efficientcargo utilization and better coordination.

Rivalry Among Competitors:With trucking routes extending 600 miles in a day and improved information systems and logisticsmanagement, UPS service is extending its ability to provide shorter service. Additionally, truckers areforming super regional alliances extending their organized delivery effort. There is additional competitionfrom UPS, who is guaranteeing ground transportation service that rivals FDX.

In the international arena, since there is expected to be more growth than in the US, domestic competitorsare also implementing global and multi-national strategies. UPS announced in November, 1999 that theyplan to build a European network, obtain airline authority to operate in Asia and build its market presencein Latin America. UPS is already in 200 countries and territories.



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Excitement over the UPS initial public offering caused the stock price to rise from its initial price of $50 to$70 ½ after the first week of trading. With employees (38% of the company) owning 90% of the multi-billion company, the company has built-in incentives to employees. With 62% of the company left towatch from the sidelines, this may backfire in the area of labor negotiations

Challenges

Bargaining Power of Buyers: Diversion of Cargo from air to groundThere will be a continued “squeeze” on profit margins as buyers (companies and individual consumers)switch to ground transportation services for less time sensitive deliveries.

Threat of Substitutes:• E-commerce Opportunities. The small package segment of Internet ordering/shipping is likely to be

through UPS and The US Postal Service. Some industry observers think that there will not be anappreciable increase in business due to e-commerce, since it is just a “shifting” the form of transport,but really no new net demands were created.

Type of Opportunity Timeframe Expected Growth ReferenceBusiness to Business 1998 – 2003 $43 B – 1.3 TrillionBusiness to Consumer 1998 – 2003 $ 8 – 108 BillionTotal electronic commerce 1998 $ 13 Billion BCG ConsultingTotal electronic commerce 1998 $ 5 Billion Market CorpTotal electronic commerce 1998 $ 7.8 Billion Forrester Res.

We believe there is a perception that FDX is an expensive way to send low value items. Most of thegrowth in internet retailing has been in the form of low price items such as books, CDs, computeraccessories and software. Consumers are opting for 2 to 3 day deliveries weighing the cost of the article asa benchmark against the price of the shipment. UPS has benefited the most from this since they arepositioned as the leader in the ground transportation segment.

• Broad band. We strongly may pose a significant long-term threat to FDX’s core competency, which isthe delivery of 5 pound or less documents. We think that this threat is propelled by the close tolightning delivery speed of the Internet. Email has already begun to drive toward the obsolescence oftransferring some information physically through delivery services. However, there are still somedocuments that are more difficult to transmit (timeliness, speed, quality, priority of electronic mail,etc.). The mode of delivery is still relegated to physical delivery because technology hasn’t made itselectronic transfer seamless and easy. However, in the future where broadband technology will bepervasive, this created the biggest threat to FDX’s existing business package service. Initially,broadband will be available between large metropolitan areas.

• Security and Encryption Technology. Legal documents, such as real estate contracts, and businessdocuments require signatory and notary functions to certify the legality of the instruments. Thesedocuments are still transmitted physically, however, as security and encryption functions are improvedand gain confidence and are widely accepted, this will also serve as a threat to existing



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FDX: A Company Profile

Company Business and Background

FDX is the world’s largest express transportation company. Revenues in fiscal 1999 were $14 billion andthe first quarter of fiscal 2000 was $3.6 billion. There are more than 148,000 employees worldwide,serving 210 countries and 366 airports worldwide, with 643 aircraft. The ground vehicle fleet numbers43,500 worldwide. The distance driven totals approximately 2.7 million miles in the US alone. There are34,000 drop boxes, 2400 FedEx shipping sites and 7600 authorized shipping centers. The average packagevolume amounts to approximately 3.1 million packages daily, weighing in at 25.6 million pounds annually.Average daily freight volume is about 7 million pounds per day. This level of business generates more than500,000 daily calls and 63 million daily electronic transmissions

Business Segments

FedEx Domestic

Growth slowing

The domestic market is currently viewed as mature and we expect market growthat 3-4% on an annual basis. This market is composed primarily of the primaryproducts: Priority and Standard overnight packages, which also includes USfreight products. Historical year-over-year growth in FedEx domestic businesshas been in the teens.

1999 is expecting growth at a reduced rate of 6.8%. The reduced rate can beattributed to the shift from air to ground shipping preferences, the improvementsin ground transportation, such as swifter and shorter delivery routes, and themore successful deployment of UPS ground products. (See Market Forces andCompetitive Landscape sections above for an exposition on FDX’s corecompetency – the overnight delivery product)

FedEx International

Opportunities forgrowth in the midteens

FedEx has spent much effort and capital to build its network of partners andoperations in both Europe and Asia. FedEx launched EuroOne in the late 80sand AsiaOne in the mid- 90s. Although, FedEx has always operated much moreprofitably in its domestic operations than its international operations, whenFedEx enters a new region of the world, it often takes several years before itbuilds critical mass. The success of EuroOne has been overshadowed by thelaunch of AsiaOne and also the most recent crisis in Asia.

However, we believe that both international sectors can now grow in tandem, asAsia has begun its reversal of fortunes and the company has initiated thedeployment of a new $200M hub in Paris, which will greatly enhance FedExinternational revenues. We expect FedEx’s international revenue to grow at midto high teens in the near future. Even though the expected growth figures arehigh, the existing base volume is low.

RPS

Gargantuan obstaclesto catch up to UPS, theGodzilla of GroundTransport

FDX acquired RPS in January 1998. RPS is in the ground, non-expressbusiness-to-business delivery of parcels weighing less than 70 pounds. RPS’sshare of the estimated $18 B total ground market is currently estimated at 11%.In July 1999, FDX began its deployment of RPS, thereby taking steps to addressFDX’s poor share of the business-to-residential market. Although we believethere is opportunity in this market, we believe FDX has major hurdles ahead.

UPS is the Godzilla of Ground Transport and has over 75% market share. In



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addition, UPS has the density of labor and networks to deliver products business-to-residential. FDX will need to significantly build brand recognition as a viableground transportation competitor, as well as build the labor force to measure upto the Godzilla of Ground Transport. In the near term, we estimate that FDXmay not achieve market share improvements with this product and foresee somediminishing market share as UPS aggressively postures to maintain and improveits market share. Should there be significant improvements in this area, this maybe a signal to review the existing recommendation.

Viking andRoberts/FDXLogistics

We expect FDX to sell these two operating units. Thus we will exclude thesetwo units from our discussion.

The growth trends mentioned above are shown graphically in the chart shown below. The categories arefurther defined below:• Previous – Fiscal Year Ending May 1998, Actuals• Current – Fiscal Year Ending May 1999, Actuals• F1 – Fiscal Year Ending May 2000• F2 – Fiscal Year Ending May 2001

(See Exhibit 4 for detailed projections)

Management

The most recent CEO, Tom Weise, who was at Fred Smith’s (the founder) side from the beginning,recently announced retirement. This paves the road for the current COO, to take the realm. The new COOhas significant international office leadership experience, as well as having had responsibility for sales.This is another visible signal that the company’s focus is on international expansion and is looking toleverage e-commerce to build, maintain and obtain new client relationships.

0 . 0 %2 . 0 %4 . 0 %6 . 0 %8 . 0 %

1 0 . 0 %1 2 . 0 %1 4 . 0 %1 6 . 0 %1 8 . 0 %2 0 . 0 %

P r e v io u s C u r r e n t F 1 F 2

P r e v io u s 1 7 . 6 % 1 2 . 3 % 1 9 . 0 %C u r r e n t 6 . 8 % 6 . 1 % 1 1 . 1 %F 1 4 . 9 % 1 2 . 4 % 1 0 . 9 %F 2 4 . 3 % 1 5 . 4 % 9 . 8 %

D o m e s t ic I n t e r n a t io n a l R P S



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SWOT Analysis: Strengths, Weaknesses, Opportunities and Threats

Strengths• FedEx is secular brand• Largest market share in airborne service• Superb service: 99%-Plus on-time service level• First in using the WWW: tracking products in

transit• One-stop shopping

Weaknesses• Significantly smaller ground market share than

UPS (75%): 11% domestic through RPS• B2E strategy did not live up to management’s

prediction: consumers chose ground instead ofair freight products

• High level of debt to service• Unpredictability in FedEx’s operating model:

Quality of Earnings concerns

Opportunities• Cross marketing existing FedEx and RPS

products• Increasing ground freight activities in the B2B

business• The strong network in Asia through AsiaOne:

the nature of the geography in Asia may benefitFedEx core competency, air freight; for fiscal2000, potential 100% growth opportunity

• Air freight to grow 2x-3x in the next twentyyears: 3.52% - 5.64% annually

• Growth of global business economic andenterprise service

• First international mover advantage in China• Global supply chain services

Threats• UPS is gaining ground on the domestic air

freight market share• Increasing jet fuel prices: trend will continue• Broadband and internet: email and online-

security may lessen the need to courierovernight deliveries: electronic signatory

• Emerging potential threat: non-asset basedonline providers: Expeditors, Circle, Eagle, CHRobinson, Hub Group (online freight matchingcompanies)

• Rising interest expense: although this can besomewhat mitigated by fixed debt expenses(operating cash requirements and stockrepurchase plan)

• Domestic growth is projects to grow at verylow single digit rate

• Growing Airborne and European contendersnot too far behind

• UPS as an alternative investment choice for theinvestment community

Brand Strength

Oldest and foremost air express brand, Federal Express, also known as FedEx or FDXWhen you think overnight delivery, you think “FDX”. The brand is synonymous with quick, reliabledelivery. The brand is also well known by the public for being able to track your package via the internetfrom source to destination, adding another element of customer service and window into the business.

RPS ground transportation brand not well knownFDX will struggle to create a brand in RPS that can be compared to the overwhelming dominance that UPShas (75%) in the express ground delivery segment. People today think of FDX as a premium brand, thatunder the right set of circumstances, one would pay a higher cost for overnight door to door service. FDXis thought of as the costlier alternative, therefore, one does not

New Supply Chain Logistics Products and Business Building ProductsThese products have been introduced as a means to allow FDX customers to link their existing informationsystems to FDX’s formats and provide tools for FDX’s customers to communicate delivery to theircustomers. The product brand names are as follows: InterNetShip (track all orders via an FDX account,Shipping applications (Ship API, Track API, Direct Link), Express Bridge (tell your customers whenthey’ll have their order)



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Even though there are trademarked services and products in the pipeline, it is not clear that there is acoherent business locomotive that delivers shareholder value.

Stock Price PerformancePerformance/Analysts’ opinions Overview

Oct 98 Dec 98 Sept 99 Oct 99Analyst Meeting(1ST called by FDX in6 years)

Barrons articleon e-commerce

ShareBuyback

DisappointingQuarterlyEarnings

Events and Impact on PerformanceThe FDX stock has seen a dramatic rise and a fall since October 1998, when the company hosted a well-attended investor meeting. Expectations started to build on cash flow improvement and e-commercepotentials. Then an article appeared in Barron’s in December 1998 discussing that FDX is going to benefitfrom e-commerce and should command much higher valuation just as the Internet companies do. Thisreport turned out to be rather premature, as the primary benefactor of the rapidly growing e-commerce isthe standard ground shipping company UPS with its business-to-residential coverage. FDX, on the otherhand, is focused on business-to-business market, which can be more lucrative in the future but has not yetgreatly benefited from the e-commerce trend. The direct comparison against UPS, which became publiclast month, will be unfavorable to FDX and will likely keep its stock price under pressure until the marketstarts to impound higher revenue growth in Europe.CapitalContrast to the previous three years when a small amount of shares were issued, FDX has aggressivelymoved into a share buyback program, which was announced in September 1999. The board approved 15million shares, or approximately 5% of outstanding shares, to be repurchased. It is estimated that thecompany has completed about 60% of the whole program during late September and early October at anaverage price of $40.56, leaving 6 million additional shares to be bought back. In addition, there is anexpectation that the company is likely to apply the selling proceeds from two asset sales in February 2000to implement additional stock buyback for 3% of the outstanding shares. These repurchases are typically



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interpreted positively, as it sends a signal that the management believes the stock is undervalued. Someanalysts argue, however, that the company may not be making the best capital allocation decision since themoney may be better spent to pay down debt.

According to the four ratios that James O’Shaughnessy advocates as useful measures for stock evaluation,FDX appears to fall into the category of stocks that are more likely to appreciate in the future. Profitmargins and ROE, where FDX has shown improvement, are said to be of little use in stock analysis, asthese factors are already impounded in the share price.

Volume and Price Momentum

Earlier in the year, for about a six-month period, the geometric rise in FDX’s stock price was pure Internethype, initiated by the Barron’s article and the subsequent avaricious appetite of the investment communityto identify the next business-to-consumer Internet play. After doubling the stock price within the sameperiod, the ludicrous rise was guillotined by an earnings warning. Further, reports surfaced that FDXwould not stand to gain as much from business to consumer fueled the charred stock price with moreoxygen. The stock currently trades within a narrow band between $36 to $46, leaving no clearprognostication of a directional momentum. Aside from noise traders, we believe the investmentcommunity is eagerly awaiting 2QF99 results to substantiate the next positioning. We believe there will betremendous negative price momentum if FDX fails to meet expectations.

Relative Performance

Chart – Performance Relative to the S&P500

Insider Trading

According to Vickers Institutional Research, there was only 1 insider trade over the previous 6 months: apurchase of 1000 shares. Since there isn’t a lot of insider trading, one can not draw any conclusions aboutwhether management is “bearish” or “bullish” on the stock.



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Institutional Ownership

Institutional investors currently own 65.25% of the 194.819 million shares outstanding. This doesn’tappear to be an inordinate amount of institutional investment. Purchase activity for the last three months isdelineated below:

• 3 Month Net Purchased - 14.710 million shares• 3 Month Shares Purchased 34.593 million shares• 3 Month Shares Sold 48.764 million shares

Short Interest

The number of shares for which there exists a short interest increased from August through November asdetailed in the following chart. The increase in short interest indicates the possibility that investors feel thatthe stock may be overvalued.

Month Shares % Outstanding % Float Days

11/08/99 8.884 2.976 3.234 5.42410/08/99 6.355 2.129 2.313 2.37009/08/99 3.419 1.145 1.245 1.97308/09/99 3.220 1.078 1.172 2.067



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Financial Analysis

ROE DecompositionROE DecompositionFDX has registered higher ROE for the past three years mainly through profit margin improvement. Thedouble-digit ROE, however, has been supported by the financial leverage, which remains fairly highcompared to its peers in the industry.

ROE Decomposition1999 1998 1997

Profit Margin 4.11% 3.60% 1.71%Asset Turnover 1.65 1.69 3.15ROA 6.78% 6.11% 5.40%Financial Leverage 2.16 2.21 2.08ROE 14.64% 13.48% 11.20%

Overall Profitability

FDX has improved its profitability on various measures over the past three years as the table indicates.This trend needs to be carefully observed, however, as lower fuel costs have contributed to the marginimprovement. The largest expense item is salaries and employee benefits, which are likely to edge up, asthe labor market remains tight.

Profitability Analysis1999 1998 1997

Gross Margin 30.47% 30.04% 28.39%Operating Margin 6.93% 6.82% 5.14%Profit Margin 4.11% 3.60% 1.71%

Asset Efficiency Analysis

Despite the improvement in profitability, FDX has so far not been able to increase its efficiency in assetutilization. In fact both A/R turnover and PP&E turnover have slightly deteriorated over the past threeyears. As it plans to enhance its infrastructure, especially in the international markets, these turnovers maycontinue to be sluggish.

Asset Efficiency Analysis1999 1998 1997

Inventory Turnover 35.52 31.54 36.32A/R Turnover 8.19 8.31 9.04PP&E Turnover 1.28 1.33 1.42Inventory Turn-Days 10.28 11.57 10.05A/R Turn-Days 44.57 43.94 40.37



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Cash Flow Analysis

Because FedEx merged with Caliber, a ground transport company, to form FDX in 1996, it is difficult tocompare the cash flows for FDX before 1996. As a result, we are showing the information for the CashFlow Analysis from 1996 to the present. The composite graph shown below is characteristic of a companyin the more mature phase of the company lifecycle curve (introduction, growth, maturity, decline). Thecompany generates sufficient cash flow from operations, such that it is not as dependent on the capitalmarkets.

Chart – Sources and Uses of Cash Flow

Cash Flow from Operations (CFO)FDX has consistently generated a positive cash flow from operations since forming the newly mergedcompany, FDX. Despite its slight decline in cash flow from operations from 1996 to 1997, FDX was ableto rebound in 1998 with a 45% increase in CFO. Even though trends in the industry reveal increasedmargin pressure, FDX’s margins improved by 7.8% during the fiscal year ending 1999.

Cash Flow from Investing (CFI)Cash flow from investing has typically been between $1.45 and $1.47 billion. This number is primarilyinfluenced by changes in investments in property, plant and equipment. Between 1997 and 1998, FDXcash flows from investing were between $1.76 and $1.88 billion. This represents a 23% increase ininvestment over 1996 levels of $1.35 billion.

Cash Flow from Financing (CFF)Over the past year, the company has been generating a higher cash flow from operations and as a result,employing the excess cash to pay down debt. No new debt was issued in fiscal year ending 1999. Also in1999, the company issued $50 million of new equity. Assuming that the stock was priced at an average of$50 per share, this stock issuance represents approximately one million shares: a relatively minor issuance.In 1998, the company issued new debt (less than in 1997), but also paid down twice that amount of debtthat it borrowed. The company may have reduced its debt level in response to the fact that it is more highlyleveraged than its peers. FDX may also be becoming more sensitive to investor concern over its high debtburden.

Altman’s Z-Score

Although we do not believe that FDX is in danger of bankruptcy, we ran Altman’s bankruptcy predictormodel for completeness sake. The model predicts bankruptcy when the Z score is less than 1.81. Therange between 1.81 and 2.99 is considered a gray area. Altman’s Z-score model is as follows:

-2,000,000

-1,000,000

0

1,000,000

2,000,000

1996 1997 1998 1999

CFO CFI CFF


Where X1 = net working capital/total assetsX2 = retained earnings/total assetsX3 = EBIT/total assetsX4 = shareholders’ equity/total liabilitiesX5 = sales/total assets

L

Fco1cacoh

FDX Z-Score

2.89

The score for Fedex falls into the grayarea or the “zone of ignorance”. This maybe something to watch more closelyespecially if Fedex does not meet its

Z = 1.2(X1) + 1.4(X2) + 3.3(X3) + .60(X4) + .998(X5)

FDX 1999 Financials

Net working capital = $116,302Total assets = $10,648,211Retained earnings = $3,615,797EBIT = $1,163,086Shareholders equity = $4,663,692Total liabilities = $5,984,519Sales = $16,773,470


December 5, 1999

16

iquidity & Solvency

DX does not have any apparent liquidity problem. While leverage ratios have come down over the pastuple of years, coverage ratios have improved. The company clearly changed its financing policy after

997, gradually moving from debt towards equity financing. This is in line with the increase in operatingsh flow for the same period. The overall debt level, however, still remains much higher that ofmparable companies and could potentially hurt the future profitability if interest rates continue to move

igher movement.

revenue target goals.



December 5, 1999

17

Accounting

Financial Position

FDX Corporation maintains a healthy balance sheet. As of May 31, 1999, the company had $325 millionin cash, $2.15 billion in net receivables, and long-term debt of $1.36 billion. In 1999, while total assetsincreased by 10%, long-term debt decreased by 2%. Debt to total capitalization has dropped from 33% in1997 to 23% in 1999. Operating performance has also been strong: for the 1999 fiscal year, annualrevenues increased 6%, margins improved from 6.4 to 6.9%, and net income rose 25%.

Review of Accounting Policies

• Fiscal Year: The Company operates on four, three-month quarters with a fiscal year ending May 31.

• Revenue Recognition: Revenue is recorded based on the percentage of service completed forshipments in transit at the balance sheet date.

• Consolidation: The consolidated financial statements include the accounts of FDX Corporation and itssubsidiaries. All significant inter-company accounts and transactions have been eliminated.

• Property and Equipment: While ordinary maintenance and repairs are expensed as incurred,expenditures for major additions, improvements, flight equipment modifications, and certain overhaulcosts are capitalized. Depreciation and amortization of property and equipment is provided on astraight-line basis over the asset's service life or related lease term as follows:

Flight equipment 5 to 20 yearsPackage handling and ground support equipment and vehicles 5 to 30 yearsComputer and electronic equipment 3 to 10 yearsOther 2 to 30 years

Aircraft airframes and engines are assigned residual values ranging from 10% to 20% of asset cost. Allother property and equipment have no material residual values. Vehicles are depreciated on a straight-line basis over five to ten years.

• Deferred Gains: Gains on the sale and leaseback of aircraft and other property and equipment aredeferred and amortized over the life of the lease as a reduction of rent expense.

• Deferred Lease Obligations: Rent expense on certain of the Company's aircraft and facility leases isrecorded on a straight-line basis over the lease term. Deferred lease obligations represent thecumulative difference between rent expense and rent payments.

• Capitalized Interest: FDX capitalizes interest on funds used to finance the acquisition andmodification of aircraft and construction of certain facilities up to the date the asset is placed inservice.

• Spare Parts, Supplies and Fuel: Spare parts are stated principally at weighted-average cost; suppliesand fuel are stated principally at standard cost, which approximates actual cost on a first-in, first-outbasis. Neither method values inventory in excess of current replacement cost.



December 5, 1999

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The Beneish Model for Earnings Manipulation

The Beneish model reveals that FDX is not likely to be an earnings manipulator. The M-score for the 1999Five and Eight Variable models are –2.92 and –2.90, respectively. Since these numbers are less than –2.22,the model suggests that there is very little chance that earnings manipulation occurred. A detailed analysisof the components of the Beneish model follows:

• DSRI: Days Sales in Receivables Index. The Company allowed its net receivables balance to increaseat twice the rate of sales growth. Although manipulators typically reveal high DSRI values, we feelthat the increase is reasonable; especially in light of the fact that total assets increased by the samepercentage.

• GMI: Gross Margin Index. Gross margins increased from 6.4 to 6.9% during 1999. This results in aGMI of .919 that lends to the premise that FDX is not likely to be a manipulator.

• AQI: Asset Quality Index. Since FDX did not yield a significant change in the level of soft assets,AQI had very little impact on the Beneish calculation.

• SGI: Sales Growth Index. An SGI of approximately 1.115 and 1.057 in 1998 and 1999 respectively,indicates that the Company’s sales have continued to grow, but at a slower pace. A high SGI pointstowards moderate, controllable growth. Since the 1999 SGI is relatively moderate, the number doesnot indicate potential manipulation by FDX.

• DEPI: Depreciation Index. FDX’s DEPI of 1.039 and 1.025 in 1998 and 1999 respectively, indicatesthat the rate at which depreciation is slowing is moderating. This is consistent with the Company’sstrategy if continued investment. Additionally, the ratio is in line with the increase in the total level ofassets employed.

• SGAI: SG&A Index. Since SGA expense increased at a rate that exceeded the rate of sales increase,the SGAI of .991 indicates possible manipulation. However, since the difference is only slight, we donot see this as a red flag; especially in light of the other parameters listed above.

• TATA: Total Accruals to Total Assets. A TATA of –0.114 and –0.107 in 1998 and 1999respectively, reveals that total accruals are relatively low. An earnings manipulator will typically havehigh total accruals.

• LVGI: Leverage Index. FDX’s LVGI of 0.936 and 0.900 in 1998 and 1999 respectively, indicates thatthe company is decreasing its debt level. Since these levels are low compared to known manipulators,FDX does not appear to be influencing the numbers.



December 5, 1999

19

Valuation

Cost of Capital / Cost of Equity Analysis

FDX’s weighted cost of capital (WACC) is approximately 8.5% based on its cost of equity of 10.54% andcost of debt of 7.22%. While the EVA model indicates much more optimistic figures for its return oninvested capital (ROIC), the market appears to apply a more moderate percentage. Assuming a reasonableestimate of 6.5%, the company is not earning its cost of capital and, hence, destroying value. In otherwords, there is no economic value added to the company’s operations unless FDX improves itsprofitability.

This poses a serious concern as FDX continues to expand its international infrastructure. Although thecompany has generated a healthy operating cash flow, any business slowdown may lead to a cash shortagethat may call for additional debt issuance. This would add to FDX’s already high debt levels, increasingthe cost of debt, thereby, the overall cost of capital.

EBO Analysis

The EBO valuation model revealed an implied price of $21.60, thus implying significant overvaluation inthe current financial markets. In arriving at our valuation, we used FirstCall analyst consensus earningsforecasts of $2.17 and $2.52 for the fiscal years ended 2000 and 2001, respectively. As described above,we based our model on a growth rate of 8%. We used a discount rate of 10.548%, calculated based on theAir Courier SIC Code 1103. Based on historical data and industry analysis, we employed a Target ROE of12%.

Sensitivity analysis: In order for the EBO to arrive at a valuation that is consistent with the market price,one might consider one of the following scenarios:

• Decrease the discount rate to approximately 7.3%. A discount rate at that level would be unreasonable,since the company has a cost of capital that is higher than 8.5%.

• Increase the Target ROE to 20.2%. In the Air Courier industry, all ROE’s tend to converge towards12% over time. Since the company does not maintain a sustainable competitive advantage, anythingsignificantly higher would be completely unreasonable.

• Assume a long-term growth rate of 33%. Although such a rate may be attainable for certain companiesin the technology sector, it is certainly not feasible for an Air Courier company.

Tables depicting various combinations of these variables are provided in exhibit 1.

EVA and DCF Analysis

EVA ValuationThe EVA model calculates an implied price of $42 per share. The model measures the excess after taxreturns of invested capital over the weighted average cost of capital, discounted by the weighted averagecost of capital. Going forward, the EVA model assumes the best case conditions. We felt the ROICs werefairly high in the model and even so, price the stock matched the current stock price. (Exhibit 2)

DCF ValuationThe DCF model came up with a price of $48 per share. We assumed a 8% growth rate for five years, thentrailing off to 3% for the next five years. The present value of the cash flows were discounted by the costof equity capital of 10.54% and we used a terminal value multiple of 16, the historic average high forFedEx. When we ran sensitivity on the growth rate, we found that the more FedEx grows in revenue, the



December 5, 1999

20

less money they make in free cash flow. This is consistent with our earlier findings that the return onequity is less than the cost of capital. (Exhibit 3)

Comparables Valuation

In performing a comparative market multiples analysis to determine FDX’s valuation with respect to itspeers, the company appears to be slightly overvalued.

StockVal G-Model

1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

FDX CORPORATION (FDX)PRICE 41.9 DATE 12-03-1999 QR 4.0 NET 8.5%••••STOCKVAL® EPS Lagged 1-Year

5566

88

10101212

1515

19192323

2929

3636

4545

57

71

88

THE G-MODELIR 6.07 6.07K 1.90 1.90K' 1.00 1.00NE 2.27 2.47•PE 18.5 17.0WPE 18.8 18.8WP 43 46AP 2% 11%Expected Return 1-Yr 11%

First Call Data 2000 2001 2002Mean Estimate 2.17↑ 2.52↓ NEChange -5% +16%High 2.30 2.70Low 1.87 2.10Total 12 11 # Up 2 0 # Down 7 5 House EstimatePE Ratio 19.3 16.6 NE

2000 2.182001 2.37•2002 2.572003 2.792004 3.022005 3.282006 3.562007 3.86

Normalized EarningsFYE May

G-Model: Investors can do better elsewhereThe G-Model is a close approximation to the EBO model in that stock price reflects a forecast of nextyear’s earnings. The Earnings per Share line is shifted back one year on the time scale. This aligns currentprice and next year’s earnings to their normal market relationship. For FDX, the G-Model is shown above.One change we made to the model was to change the slope of the EPS line from 10% to 8.5%. This linerepresents the earnings growth or the price growth of FDX. In all of our other valuations, we felt thateven an 8.5% growth in earnings was the best case scenario. So we feel that this model is the bestrepresentation of FDX’s best one-year outlook.

Looking at the data on the bottom panel on the left side of the graph are the G-Models theoretical valuesregarding future and current pricing. At the very bottom we see that the expected one-year return is 11%.The numbers following AP (Appreciation Potential) shows 2% and 11%. The 2% represents the amount bywhich FDX may be currently undervalued while the 11% is the expected one year return. Above the AP isthe WP or Warranted Price. At the time this model was done, the price of FDX was $41.90 per share. TheWP suggests a price of $43 per share while the one-year target price is $46 per share. This suggests thatFDX is currently fairly priced. Above WP is PE (Price Earnings) and WPE (Warranted Price Earnings).

Freight Ticker 52 52 Market Current DividendIntegrators Symbol Price Hi Lo Cap. Earnings Sales Book CashFlow ROA ROE Ratio Yield

FDX FDX 41.938 61 7/8 32 12749 18.2 0.74 2.65 7.3 5.93% 14.88% 1.027 0UPS UPS 66.625 76 15/16 61 76885 34.9 2.83 11.3 22.77 10.56% 26.26% 1.460 0.45%

Airborne Freight Corporation ABF 24.5 42 9/16 19 1/2 1206 10.7 0 0.39 4.37 9.58% 19.07% 1.308 0.65%CNF Transportation CNF 30.562 45 7/8 28.38 1712 9.6 0.32 1.97 5.4 5.33% 16.17% 0.918 1.31%Pittston BAX Group PZX 10.062 11 5/8 6 195 9.2 0.1 0.62 3.44 1.03% 2.32% 0.976 2.39%

High 76885 34.9 2.83 11.3 22.77 10.56% 26.26% 1.460 2.39%Median 1712 10.7 0.32 1.97 5.4 5.93% 16.17% 1.027 0.65%

Low 195 9.2 0 0.39 3.44 1.03% 2.32% 0.918 0.00%

Price



December 5, 1999

21

These ratios are also very close suggesting that the stock is fairly priced. The PE is the currently price toearnings ratio and the WPE is the price to earnings ratio based on the existing G-Model settings. The othervalues, IR, K and K1 represent the interest rate of the five-year Treasury bond, the equity market riskpremium and the company specific risk premium respectively.

What the G-Model for FDX suggests to us is that either FDX is fairly priced or just slightly undervalued.In either case, investors seeking above average market returns would do well looking elsewhere.



December 5, 1999

22

Exhibit 1 – EBO Model

EBO Sensitivity Analysis

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December 5, 1999

23

Exhibit 2 – EVA Analysis

WACC 8.50%Forecast

1999 2000 2001 2002 2003 2004 2005 2006 2007Earnings Before Interest and Taxes (EBIT) 1,163,086 1,105,036 1,193,439 1,288,914 1,392,027 1,503,390 1,593,593 1,673,273 1,723,471 Taxes on EBIT: Add: Income taxes from income statement 429731 423,627 457,390 493,857 533,244 575,786 610,237 640,664 659,818 Add: Tax shield on interest expenses* 36,864 39,686 42,737 46,034 49,599 52,479 55,018 56,603 Less: Tax on Interest Income* 0 0 0 0 0 0 0 0 Less: Tax on non-operating income* 0 0 0 0 0 0 0 0Less: Taxes on EBIT: 460,491 497,076 536,593 579,278 625,385 662,716 695,682 716,421 Add: Change in deferred income taxes 0 0 0 0 0 0 0 0Add: Goodwill Amortization 0 0 0 0 0 0 0 0Net Operating Profits After Taxes, NOPAT 644,545 696,363 752,321 812,749 878,005 930,877 977,590 1,007,049 Add: Depreciation & Amortization (except goodwill) 1,141,267 1,232,568 1,331,174 1,437,668 1,552,681 1,645,842 1,728,134 1,779,978Less: Net Change in Working Capital 105724 10,591 20,434 22,069 23,834 25,741 20,850 18,418 11,603Less: Net Other Adjustment -19337 0 0 0 0 0 0 0 0Less: Net Capital Expenditures*** 1762979 953,525 1,173,875 1,267,784 684,604 1,423,976 1,153,420 1,018,854 641,878Free Cash Flows to the Firm (FCFF) 821,696 734,623 793,642 1,541,979 980,969 1,402,448 1,668,452 2,133,546

Invested Capital = ICt-1 + It 1,849,366 2,493,911 1,660,479 1,946,630 2,102,602 1,586,443 2,380,594 2,151,861 2,044,322 EVA 487,349 696,363 752,321 812,749 878,005 930,877 977,590 1,007,049 PV of EVA 449,169 591,530 588,998 586,459 583,913 570,576 552,266 524,340 ROIC 35% 28% 45% 42% 42% 59% 41% 47%

Initial investment 1,849,366 Sum of EVA 10,686,689 Firm Value 12,536,055 Shares outstanding 297,987 Price 42.07$



December 5, 1999

24

Exhibit 3 – DCF Analysis



December 5, 1999

25

Balance Sheet Input to DCF Model



December 5, 1999

26

Exhibit 4 - Growth Forecast

FDX Corp. - Growth Forecast

Revenues F1998 F1999 F2000E F2001E F1999 F2000E F2001EFedEx Domestic 9,521 10,172 10,670 11,129 6.8% 4.9% 4.3%FedEx International 3,590 3,809 4,281 4,941 6.1% 12.4% 15.4%FedEx Total 13,111 13,981 14,952 16,070 6.6% 7.0% 7.5%Caliber Total 2,595 2,794 3,126 3,452 7.7% 11.9% 10.4%Total 15,706 16,775 18,078 19,522 6.8% 7.8% 8.0%

Operating ExpensesFedEx

Salaries and employee benefits 5,774 6,225 6,662 7,173 Rentals and landing fees 1,233 1,318 1,474 1,617 Depreciation and amortization 845 911 988 1,069 Maintenance and repairs 802 890 1,012 1,024 Fuel 709 594 768 808 Other 2,961 3,170 3,254 3,495 Total 12,324 13,108 14,158 15,186

Caliber 2,371 2,502 2,807 3,087 Total 14,695 15,610 16,965 18,273

Operating Income 1,011 1,165 1,113 1,249

Revenue Growth Projected to be 8%

Domestic growth to be sluggish

International is the only bright spot with double-digit growth

swot analysis federal express

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