Is FedEx the Canary in the Coal Mine?

04/05/2007 12:00 am EST

Focus:

Robert Walberg

Financial Writer, MSN Money

Robert Walberg, columnist for MSN Money, says FedEx's recent earnings report may presage deeper problems for the US economy.

Maybe former Fed Chairman Alan Greenspan's warning about a possible recession isn't so far-fetched.

Consider the disappointing quarterly results recently announced by FedEx (NYSE: FDX), often considered a bellwether for the US economy. Though the package-delivery company's earnings of $1.35 per share beat the consensus Wall Street estimate by two cents, they were still 1.9% lower than a year ago. Revenue was up by 7% year over year but still shy of estimates by 1.2 percentage points.

And conditions aren't likely to improve anytime soon. Management cited the slowing economy and suggested it won't meet its goal of 10% to 15% earnings growth this year. In fact, the company narrowed the range of its earnings for fiscal 2007 to $6.70 to $6.85 a share, from $6.60 to $6.90.

FedEx's management sounded optimistic about the economy, of course, but you shouldn't take the bait, especially given the company's operational performance. Its operating margins fell across all four-business units, and operating income grew in only the ground-delivery division.

Considering that FedEx has pushed through numerous price increases and surcharges in recent quarters, it's not clear that there's room to improve margins through pricing. That means cutting costs, something that might be difficult given the company's contract negotiations with its pilots. Expansion efforts in China and updates to its fleet also suggest that reducing costs may be difficult.

FedEx also faces an increasingly competitive environment. In addition to the pressures coming from United Parcel Service (NYSE: UPS) on the ground, FedEx faces express competition from DHL, which is determined to use aggressive pricing in order to gain share in the lucrative US market.

Then there is the continual underperformance of the Kinko's division. Operating income fell by 43% last quarter, with operating margins slipping all the way down to 0.8%. Weakness was blamed on lower-than-anticipated copy revenue. Rather than throwing more good money after bad in attempts to turn this struggling unit around, management would better serve shareholders by unloading the business so that it can focus on core operations.

Not all the news out of FedEx is negative, however. The company is well positioned to exploit the Chinese market over the long term. Meanwhile, continued double-digit growth in e-commerce will also underpin the company's operations.

Nevertheless, the near-term outlook for FedEx is clouded by economic uncertainties and significant margin deterioration. Until there's solid evidence of improvement on both fronts, investors are advised to take profits by selling the stock. FedEx has a downside risk over the next six months in the $98 area. Such a move would represent a decline of nearly 11% off current levels. (The shares closed at about $106 Wednesday.)

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