Try shipping your money into FedEx

By Jon Markman

On a recent Tuesday, my daughter ordered a pink, 4-gigabyte iPod Nano. She asked for engraving with her name, and we took the free-shipping option. Naturally, she immediately began counting down the six to eight business days that the Apple Computer (AAPL, news, msgs) Web site said it would take to get the device, figuring it would appear the next week.

Instead, we received it via FedEx (FDX, news, msgs) three days later. The tracking information on FedEx's Web site said it had been shipped out of Shenzhen, China, on Tuesday night before touching down in Anchorage and Indianapolis, and then arriving in Seattle early Friday. I don't know about you, but the speed and efficiency of a supply chain that can send an engraved device from China to Seattle in three days strikes me as amazing and got me wondering about FedEx's role in the Apple success story.

I recommended FedEx shares in the first half of the year and made 15%. I'd like to circle back and see if it's worth owning again now that the shares have endured a substantial correction. (It's up only 5% for those who held it all year.)

One student's C grade

Any mention of FedEx is usually followed by the famous story surrounding its creation, which goes something like this: Founder Fred Smith wrote a paper for an economics class while at Yale University, outlining the idea that would become Federal Express, for which he received a C grade.

The part that is not normally reported is that Fred doesn't remember his grade and that the paper was not a fully realized business plan. It was on the computerization of banking and the necessity of maintaining efficacy through reliability. For the likes of computer makers such as IBM (IBM, news, msgs), that meant finding a reliable way to ship parts to far-off branches. Back then, all you had was the post office, and that didn't cut it. Smith saw the need for a quicker, more dependable and more geographically diverse delivery system. What followed was the birth and rapid growth of FedEx, which became the first cargo carrier to have a fleet of jet aircraft.

The Memphis, Tenn., company operates in four key segments, which are color-coded on trucks and aircraft: FedEx Express, FedEx Ground, FedEx Freight and FedEx Kinko's. Express is the most familiar, delivering packages and letters at definite times to 220 countries globally. Ground delivers small packages throughout North America, with cost savings but a slower delivery time, via independent owner-operators. Freight offers less-than-truckload services. Kinko's provides a retail outlet for the company's services through 1,200 copy centers. FedEx also offers critical-shipment delivery and customs brokerage service.

From its public offering in 1978 until now, the company has grown more than 18% annually. One thousand dollars invested in the initial public offering would now be worth nearly $112,000 today. Success has come because the company has learned to benefit from the New Economy of online retail, as the iPod example demonstrates. FedEx also has a contract with the U.S. Postal Service for the use of its cargo planes for air transport of mail. The contracts are worth $1 billion per year. In addition to civilian mail, FedEx recently won a U.S. military airlift contract, which could add another $1 billion in sales. When it comes to the government, FedEx can move it -- just so long as they bring a cool billion.

Major expansion internationally

The company is also aggressively growing through acquisitions and continues to expand operations internationally. In China alone, the company plans to operate in 320 cities over the next five years, up from the current 220. This move mirrors the Chinese government's efforts to develop inland areas of the country. FedEx recently completed the purchase of Watkins Motor Lines, a long-haul less-than-truckload carrier, for $780 million cash.

Freight has been a big driver of income growth over the past few years, so the acquisition makes good sense, especially since FedEx now offers nationwide less-than-truckload service instead of just regional one- to two-day service. The company is also building a 48,000-square-foot freight service center in Kentucky with 85 loading docks.

A recent bout of good news came when the 5,000 pilots flying FedEx's fleet of cargo jets agreed to vote on a labor contract, with union leaders recommending approval. Voting will run through Oct. 17. It was just one year ago that negotiations stalemated.

With labor hurdles clearing and business expanding, I think FedEx can continue to grow earnings 18% annually over the next two years, assuming the world economy does not slow too dramatically. First-fiscal-quarter profit, reported two weeks ago, blew past consensus estimates, rising 40% on remarkable demand for ground and international express shipments. The company reported income of $475 million, or $1.53 per share, versus a prior-year profit of $339 million, or $1.10 per share. Revenue rose 11 percent to $8.54.

I expect fiscal 2008 to bring in up to $8.10 in earnings per share. Slap an 18 price-earnings ratio on that and you can see the potential for $145 a share by mid-2008, up more than 34% from the current quote. If the market softens here in October, try to buy a pullback to the $100-$103 area. That's only a 5% to 8% drop from current levels but would signify to me that the fair-weather holders are out of the stock and that the serious shareholders are back in.

Jon Markman is editor of the independent investment newsletters Strategic Advantage and Trader's Advantage. While he cannot provide personalized investment advice or recommendations, he welcomes column critiques and comments at jon.markman@gmail.com; put COMMENT in the subject line. At the time of publication, Markman did not own or control shares of companies mentioned in this column.