FedEx Gets Bond Market Upgrade

Company’s debt trades higher as work related to online retail increases.

Debt traders are indicating FedEx Corp., after an eight-year drought, is headed for a second 2012 credit upgrade as rising online commerce keeps ground deliveries growing even as the U.S. economy shows signs of faltering.

Credit-default swaps linked to debt of the operator of the world’s largest cargo airline have traded at levels implying it should be graded A3 since May 7, according to Moody’s Corp.’s capital markets research group, one level higher than its Baa1 mark from the company’s rating arm. FedEx’s 8 percent bonds due in January 2019 yield 2.59 percent, less than the 2.85 percent on all A rated corporates due in five to seven years, according to Bank of America Merrill Lynch index data.

FedEx, founded by Chief Executive Officer Fred Smith four decades ago, is profiting from rising sales at online retailers such as Inc. that use it to ship goods. The company’s ratio of debt to earnings before income, taxes, depreciation and amortization has declined to 0.32 times on May 31 from 1.10 times in 2004 as income rose in each of the past three years.

“More people are buoying the e-commerce market, which is good news for FedEx,” Brian Studioso, an analyst at CreditSights Inc. in London, said in a telephone interview. “They have been working hard on the ground business. Customers are downshifting from the high margin express business to ground.”

The ground business of the Memphis, Tennessee-based company achieved a 20 percent operating margin in the fourth quarter of the fiscal year ended May 31. Sales were driven by “the growth of e-commerce” with increased demand for products ordered from companies such as Amazon and Wal-Mart Stores Inc.’s online unit, Chief Financial Officer Alan Graf said during a June 19 teleconference to discuss fourth-quarter results with analysts and investors. The operating margin was a record, according to a June 19 company statement.

Jess Bunn, a spokesman for FedEx, declined to comment on a potential upgrade.

An economic bellwether because it carries everything from mobile devices to pharmaceuticals, FedEx forecast U.S. economic growth of 2.2 percent for this fiscal year, Bunn said. That’s down from 2.3 percent in December, he said.

FedEx, which had $1.25 billion of long-term debt outstanding on May 31, may attract bond investors away from United Parcel Service Inc. as they seek to curb risk from the company’s $6.5 billion acquisition of TNT Express NV, which was spun off in May from Dutch postal operator PostNL NV.


‘Higher Yield’

The purchase by UPS, the world’s largest package-delivery company, comes as Europe’s economy shrinks toward what the International Monetary Fund predicted in January will be a “mild recession” in Europe this year. It said this week the U.S. economy would experience a “tepid” recovery.

FedEx’s $250 million of 7.375 percent notes due January 2014 traded April 30 at 111 cents on the dollar to yield 0.91 percent, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. UPS’s $1 billion of 3.875 percent notes due April 2014 were quoted at 106 cents for a yield of 0.57 percent on June 15.

“FedEx has a higher yield and less event risk than UPS right now,” Studioso said. “TNT is still the fourth-largest competitor in the industry, so any kind of integration comes with risks.”

Moody’s Investors Service raised its rating on FedEx to Baa1 from Baa2, in January, citing the shipping company’s “franchise strength” in the market for express services and growth in the ground segment, “which has helped it sustain good earnings and free cash flow generation over the economic cycle.” It was the first ratings change at Moody’s since 2004, according to data compiled by Bloomberg.

Standard & Poor’s has rated FedEx BBB, one level below the current Moody’s grade, since February 2004. UPS is rated Aa3 at Moody’s and an equivalent AA- at S&P, with “negative” outlooks at both companies.

Credit-default swaps linked to FedEx declined 2.7 basis points to 90.3 basis points as of 3:31 p.m. in New York, the lowest level on an intra-day basis since March 29, and down from 133 basis points on Oct. 4, according to data compiled by Bloomberg. That means investors would pay $90,300 annually to protect $10 million of FedEx debt.

The contracts, which typically fall as investor confidence improves and rise as it deteriorates, pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt.


‘Less Risky’

FedEx, which Smith conceived in a 1965 college term paper at Yale, purchased the Flying Tigers freight airline in 1989 to gain routes to 21 Asian countries. More recently, it spent $427 million in 2007 to take over a joint venture with China’s Tianjin Datian W. Group Co.

Last year, FedEx got 30 percent of its $39.4 billion of revenue from international shipments, has been broadening its global network though smaller acquisitions than UPS. FedEx completed the purchase of TATEX, a French express transportation company this week. The company agreed to buy AFL Pvt. and affiliate Unifreight India Pvt. In 2010, followed by MultiPack, a domestic express-delivery company in Mexico.

While UPS tries to figure out how to integrate its European operations with TNT, FedEx “should have a much easier time growing with these smaller, less risky integrations,” David Ross, an analyst at Stifel Nicolaus in Baltimore wrote in a May 10 report.

FedEx agreed to buy 19 Boeing Co. 767 jets last week, the first freighters the planemaker has sold in 2012 as shippers curbed purchases amid the slowing global economy. Air cargo fell 2.3 percent in the first four months of the year from 2011, the International Air Transport Association said.

New jets will help profitability at FedEx by paring fuel costs as the economy crimps express shipments.

“Because FedEx is more oriented toward the air business, their earnings can be somewhat more volatile, but they have more leverage when things begin to pick up,” Lisa Jenkins, an S&P debt analyst, said in a telephone interview. “So you might see more of an improvement with them than UPS when the economy picks up more.”

Forrester Research Inc. said in a Feb. 27 report that e- commerce in the U.S. will grow 14 percent annually this year and next year and 10 percent in 2014.

FedEx last month predicted profit of $6.90 to $7.40 a share in the fiscal year through May, compared with $6.41 last year and an average estimate of $7.33 from analysts. The company’s Ebitda rose to $5.43 billion in the year through May 31, up from $3.93 billion in fiscal 2009.


‘So Efficient’


Revenue and earnings growth will be impacted by “weaker economic conditions” such as the European debt crisis, and slowing growth in Asia, Graf said on the earnings call. Customers are shifting from premium to deferred products as they seek to reduce shipping expenses, a trend expected to continue in 2013, executives said.

“The ground network is taking share from domestic express service because it has just gotten so efficient,” Kevin Sterling, a Richmond, Virginia-based equity analyst with BB&T Capital Markets said in a telephone interview. “From a ground standpoint it’s so much cheaper to ship, and you are seeing record margins because of e-commerce.”



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