FedEx's Dividend Hike: Is It Worth Recent Upside?

GuruFocus.com
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- By Omar Venerio

FedEx Corp. (FDX) has raised its quarterly dividend to 50 cents per share or $2 on an annual basis. This way, the stock yields almost 1.0% if the share price stays at current levels ($210). Thanks to GuruFocus we know that during the past 13 years, FedEx's highest trailing annual dividend yield was 1.20%, the lowest was 0.28%, and the median was 0.53%. Moreover, it is close to a five-year high.


What makes possible the dividend hike is the solid financial position. Also, the Piotroski F-Score of 6 indicates its financial situation is typical for a stable company. The company has a history of deploying capital through share repurchases and dividends.

The day the company announced the dividend increase, the stock moved higher. Let's try to find the intrinsic value of the stock and compare it with its trading price. But first, let's see the relative valuation.

The company is trading at a price-earnings (P/E) ratio of 29.61x, which is ranked lower than

74% of the 634 companies in the Global Integrated Shipping & Logistics industry.

Intrinsic value

The Yahoo (YHOO) Finance consensus price target is $221.96, representing an upside potential of 5.7% from actual levels so let's try to estimate the fair value. For that purpose I will use the Dividend Discount Model (DDM). In stock valuation models, DDM defines cash flow as the dividends to be received by the shareholders. The model requires forecasting dividends for many periods so we can use some growth models like: Gordon (constant) growth model, the Two or Three stage growth model or the H-Model (which is a special case of a two-stage model).

Once we have selected the appropriate model, we can forecast dividends up to the end of the investment horizon where we no longer have confidence in the forecasts and then forecast a terminal value based on some other method, such as a multiple of book value or earnings.

Let's estimate the inputs for modeling:

First, we need to calculate the different discount rates - i.e., the cost of equity (from CAPM). The capital asset pricing model (CAPM) estimates the required return on equity using the following formula: required return on stock j = risk-free rate + beta of j x equity risk premium

Risk-free rate: Rate of return on long-term government debt: risk free = 3.03%[1]. This is a very low rate. Since 1900, yields have ranged from a little less than 2% to 15% with an average rate of 4.9%. It is more appropriate to use this rate.

Gordon growth model equity risk premium = (one year forecasted dividend yield on market index) + (consensus long-term earnings growth rate) - (long-term government bond yield) = 2.13% + 11.97% - 2.67% = 11.43%[2]

Beta: From Yahoo! Finance we obtain ? = 1.49

The result given by the CAPM is a cost of equity of: rFDX = RF + ?FDX [GGM ERP] = 4.9% + 1.49 [11.43%] = 21.93%

Dividend growth rate (g)

The sustainable growth rate is the rate at which earnings and dividends can grow indefinitely assuming that the firm's debt-to-equity ratio is unchanged, and it doesn't issue new equity.

g = b x ROE

b = retention rate

ROE = (Net Income)/Equity= ((Net Income)/Sales).(Sales/(Total Assets)).((Total Assets)/Equity)


The "PRAT" Model:

g = ((Net Income-Dividends)/(Net Income)).((Net Income)/Sales).(Sales/(Total Assets)).((Total Assets)/Equity)

Collecting the financial information for the last three years, each ratio was calculated, and then to have a better approximation I proceeded to find the three-year average:

Retention rate

0.86

Profit margin

0.04

Asset turnover

1.26

Financial leverage

2.51



Now, it is easy to find the g = Retention rate x Profit margin x Asset turnover x Financial leverage = 20.11%

Because the GGM is unrealistic for most companies, let's consider the H-Model which assumes a growth rate that starts high and then declines linearly over the high growth stage until it reverts to the long-run rate. In other words, a smoother transition to the mature phase growth rate that is more realistic.

Dividend growth rate (g) implied by Gordon growth model (long-run rate)

With the GGM formula and simple math:

g = (P0.r - D0)/(P0+D0)

= ($210 x 21.93% - $2.0) ? ($210 + $2.0) = 16.95%.

The growth rates are:

Year

Value

g(t)

1

g(1)

9.89%

2

g(2)

12.45%

3

g(3)

15.00%

4

g(4)

17.55%

5

g(5)

20.11%



G(2), g(3) and g(4) are calculated using linear interpolation between g(1) and g(5).

Now that we have all the inputs, let's discount the cash flows to find the intrinsic value:

Year

Value

Cash Flow

Present value

0

Div 0

3.16

1

Div 1

3.47

2.848

2

Div 2

3.90

2.626

3

Div 3

4.49

2.477

4

Div 4

5.28

2.388

5

Div 5

6.34

2.352

5

Terminal Value

417.32

154.846

Intrinsic value

167.54

Current share price

208.00

Upside Potential

-19%



Final comment

Intrinsic value is below the trading price by 19% so according to the model and assumptions, the stock is overvalued, especially considering a margin of safety (usually 20%).

We must keep in mind that the model is a valuation method, and it should not be relied on alone in order to determine a fair (over/under) value for a potential investment.

Hedge fund gurus like Chris Davis (Trades, Portfolio), Manning & Napier Advisors Inc. and Steven Cohen (Trades, Portfolio) have initiated new positions in the stock with 460,972, 304,083, 230,298 and 125,700 shares. Moreover, Pioneer Investments also bet on this stock with an increase of 1,611.55% to 870,646 shares.

Disclosure: Author holds no positions in any stocks mentioned.


[1]{C} This value was obtained from the U.S. Department of the Treasury

[2]{C} These values were obtained from Bloomberg?s CRP function.

This article first appeared on GuruFocus.


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