Research note on DHL from today:::
DHL ON THE BRINK. We believe DHL is close to a major withdrawal
from the former Airborne, U.S. Dom. Package business, beyond its prior May
announcement. Within weeks we expect DHL could begin exiting the U.S. ground
business entirely and possibly also the Dom. Air Express business, leaving
itself with basically only import/export express rev., as it was prior to
Airborne in C02.
· FDX AND UPS WOULD BENEFIT. Depending on whether it can resolve the
still pending UPS air linehaul agreement, we believe DHL could either shrink
or remove itself entirely from the intra-U.S. express market. We estimate
DHL is down to roughly $2.6B in total U.S. dom. (ground and air) rev. While
we estimate a total shut down would improve both FDX's and UPS's Dom.
Package vols and EPS in C09 by roughly 3-6% and 3%, DHL's removal could have
a vastly larger long-term positive impact on pricing (see below).
· NEAR-TERM UPSIDE LIKELY, DRIVEN BY FUEL. We estimate that FDX's
EPS should benefit by about $0.40 (27%) y/y from net fuel in F2Q:09 (Nov).
While freight trends continue to weaken, particularly Int'l trends, FDX
should benefit for at least another 2-3 qtrs from lower fuel and our sense
is materially weaker earnings expectations are now discounted in the stock.
Today, we have raised our F2Q EPS forecast from below to above Cons.
· GROUND CONTRACTOR ISSUES CONTINUE, BUT LIKELY DORMANT FOR NEAR
TERM. We continue to believe that the Ground contractor issues that plague
FDX are not likely to go away and that longer term those issues will weigh
on FDX's valuation. However, at 13x our recession model, low-end estimates,
with little news expected on the Contractors until at least 2009, we believe
that risk is priced in.
· RAISING RATING TO OP AND SETTING $80 TARGET. Our $80 year-end C09
TP assumes a 14.5x target forward P/E applied out 14 months from now on our
then forward-year recovering C10 EPS forecast of $5.50. This also equates to
about a 16x-17x peak P/E on our trough C09 EPS forecast of $4.80.
Investment Conclusion
Raising Airfreight & Logistics Sub-Sector Weighting to Market Overweight. In
addition to raising FDX's rating from Peer to Outperform, we are also today
increasing our sector weighting on the Airfreight & Logistics transport
sub-sector from Market Weight to Market Overweight. We have recently
increased our ratings on TNT, CHRW and EXPD to Outperform and we continue to
rate UPS, HUBG and UTIW Outperform. Our other Sector weightings remain
Market Overweight for Rails and Market Underweight for Trucks.
FDX is down about 30% YTD compared to UPS down about 28%, our average
Airfreight & Logistics Index (excluding FDX) down 22% and the S&P 500 down
35%. On October 10th we upgraded FDX from Under to Peer Perform after the
stock declined 13% below our former downside target price of $77. We also
noted that near-term fuel tailwinds and DHL problems could provide near-term
upside. Subsequently last week we moved our group to recession models for
2009 which assume -2% GDP during C1H:09 and 0% growth during C2H:09. At that
time we lowered our F09 EPS forecast for FDX from $5.50 to $4.80 (compared
to current Consensus $5.18) and our C09 EPS forecast from $5.43 to $4.80 and
introduced our C10 estimate of $5.50. Today we are raising our current
November quarter F2Q:09 EPS forecast from $1.40 to $1.50 (compared to
current $1.44 Cons) based on our expectation for FDX to achieve a roughly
$0.40 y/y (27%) net fuel benefit which should more than offset weakening
U.S. and global volumes and yields.
Besides from a likely upside surprise in December when FDX reports, we
expect DHL's likely impending announcement that it is further restructuring
its U.S. domestic operations to serve as a near-term catalyst for FDX and
UPS. While we still believe DHL could finalize its pending contract with UPS
for UPS to provide air linehaul within the U.S., we also see an equally
strong possibility now that DHL just shuts down its domestic operation and
pulls out of the U.S. back to its pre-Airborne 2002 import/export-only days.
Our sense is that DHL is seeing freight diversion from customers faster than
it expected and that if the air linehaul agreement is going to succeed it
will need to be announced shortly. We also believe the value of the air
linehaul agreement which back in May was estimated (by DHL and UPS) at about
$1B in revenue per year to UPS for ten years is likely closer to 25%-50%
lower than that given continued diversion. We do not account for any volume
or profit from the DHL contract in our UPS model, nor do we assume in either
our FDX or UPS model that DHL exits the U.S. domestic package market. Thus
any new restructuring news from DHL would likely provide upside to our
current UPS and FDX expectations.
Below we have estimated the remaining revenue at DHL and how UPS and FDX
might benefit from splitting that revenue if DHL were to leave the U.S.
domestic market. Our sense is that FDX and UPS are increasingly benefitting
from DHL's issues and signing business which will likely start to show up in
their P&L over the next 3-6 months. However, as we display below, DHL's
estimated $2.6B of remaining U.S. domestic revenue would not likely generate
enough profitability during C09 for FDX or UPS to overcome downward earnings
pressure from current global volume and to a lesser extent pricing weakness.
More importantly we believe that DHL's removal from the U.S. market should
lead to a material improvement in pricing for FDX and UPS over time. Below
we estimate that each one percentage point of higher pricing during C09
would equate to about $0.37/share (8% of total EPS) and $0.20/share (6% of
total EPS) for FDX and UPS, respectively. Recently both FDX and UPS have
announced high-end historical Air and Ground list increases beginning
January 2009 and, without DHL in the equation, the opportunity to maintain a
greater % of this increase during C09 than they were able to in C08, despite
the weak economy, could increase.
Our sense is that we are not likely to further reduce our recession C09 FDX
EPS forecasts, however outside of near-term fuel benefits, we don't see much
upside until volumes and pricing begin to improve once again likely some
time in C2H:09.
On our modestly upwardly revised, still recession EPS forecasts, FDX is now
trading at 12.8x and 4.7x forward-rolling P/E and EV/EBITDA. This compares
to its past 1-, 3- and 5-year average forward P/E and EV/EBITDA's of 14.1x,
15.1x and 16.1x and 5.7x, 6.2x and 6.5x and its historical peak and trough
P/E range of 12x-20x. We believe given FDX's on-going risk to its
independent contractor Ground model that it is likely to continue to trade
below historical peak and trough ranges.
Applying a target forward P/E of about 14.5x out 14 months forward to our
then forward, recovering C10 EPS forecast of $5.50 (unchanged), implies a
year-end C09 target price of $80 for FDX. This also implies about a 16x-17x
target peak P/E on our trough C09 EPS forecast of $4.80 compared to
historical Peak forward P/E of about 20x on trough earnings. FDX is now
rated Outperform.
