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Morningstar | Shares Still Cheap After We Reduced FedEx's FVE Due to Pension Underfundedness

Express pioneer FedEx continues to refine its portfolio to increase margins and capture a greater share of global trade. Well known for overnight parcel deliveries, FedEx has improved its competitive advantage by building the capacity to handle additional modes of shipping. After purchasing assets in ground delivery and less-than-truckload freight (both domestic U.S. operations) and expanding its asset-light air and ocean forwarding network, FedEx can now handle most shipping modes. Fulfilling more of its customers' needs makes FedEx more difficult to displace and a bigger, stickier part of clients' operations. The firm is also expanding its ability to serve intra-Europe shipments.FedEx's extensive international shipping network would be difficult and costly to duplicate, giving the company a narrow economic moat. The strength of FedEx's barriers to entry was on full display when competitor DHL left the domestic U.S. parcel delivery market in 2009 after it determined the incumbent duopoly was too powerful to challenge without extended losses. We expect FedEx to exploit its competitive advantages, despite the challenges of global economic cycles and even some shippers (like Amazon) performing their own fulfillment. The TNT Express acquisition gives FedEx the opportunity to operate and improve ground operations in Europe, where we believe online fulfillment has room to grow. However, we are skeptical that it can replicate the margins there that the U.S. ground system earns, because of the flexible cost structure of the U.S. independent contractor model.We expect mix shifts to boost returns on invested capital as the firm expands high-ROIC ground operations and reaps the rewards of improving express profitability over five years. In response to weak international priority volume and growth of lower-yield international economy shipments, the firm realigned its fleet to better match demand and reduce costs. In fiscal 2018, the express segment (including TNT) produced about 55% of total sales and 45% of operating income; the higher-margin ground operation generated about 46% of total operating profit on just 28% of total sales.