Will FedEx’s Recent Indictment Impact Its Ability To Meet Short Term Obligations?

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FedEx Corporation (NYSE:FDX), a logistics and courier delivery company, had recently been indicted with drug trafficking in relation to transporting and delivering controlled substances that were sold illegally. [1]  Adding to the charges, the U.S. Justice Department has also accused the company of conspiracy to launder money.

In an indictment filed earlier in July, federal prosecutors said that the company was breaking the law by shipping drugs ordered from online pharmacies by people who had filled out online questionnaires. FedEx pleaded not guilty stating that it cannot be held responsible for the contents of the packages it transports daily. The company also stated that it had requested the Drug Enforcement Administration to provide a list of illegal online pharmacies in order to stop catering to them. However, it had not been provided one.

The latest charges allege that FedEx collected payments at the time of delivery of the drugs and had returned them to the issuer and that FedEx was fully aware of the illegal nature of the prescriptions. FedEx defended itself by stating that collection of payments at the time of delivery was a part of its “collect on delivery” service.

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If FedEx is found guilty, it faces a potential maximum fine of twice the gains from shipments by pharmacies, which is estimated to be around $820 million, meaning a total fine of $1.6 billion.  This amounts to 46.4% of FedEx’s operating profits for the fiscal year 2014 and therefore raises concerns about the company’s ability to pay-off and recover from such a hefty fine. [2] It also brings into question how the company will meet its short-term liabilities and pay dividends to its shareholders. Considering FedEx’s cash flows and strong fundamentals, we believe that the setback of $1.6 billion will not slow down the company.

See our complete analysis of FedEx here

Significant cash balances and strong fundamentals can support payment of the penalty

As on May 31 2014, FedEx had $2.9 billion of cash and cash equivalents on its balance sheet, sufficient to pay the penalty, if proven guilty. The amount has decreased significantly from $4.9 billion on May 31 2013, primarily due to repurchase of $2 billion worth of stock, around 14.8 million shares, under accelerated stock repurchase agreements. Since the accelerated stock repurchase agreements have now been completed, they will not have any impact on future cash flows. Of their active share repurchase programs, 2.1 million shares remain authorized and available for repurchase.

Turning to FedEx’s liquidity ratios, ratios that indicate a company’s ability to pay off short term liabilities, its current and quick ratio seem strong. In the fiscal year 2014, FedEx’s current ratio (current assets divided by current liabilities), which indicates the company’s ability to meet its short term liabilities, stood at 1.82. [2] This is significantly higher than its competitor, UPS’s current ratio of 1.48 as on June 30 2014, and indicates a superior ability to meet obligation in the near future. [3] FedEx’s quick ratio (cash and equivalents + marketable securities + accounts receivable / current liabilities), which indicates the company’s ability to meet its short term liabilities using most liquid assets, stood at 1.58 as on May 31 2014, again higher and favorable than UPS’s quick ratio of 1.25 as on June 30 2014.

Additionally, FedEx has access to a $1 billion revolving credit facility to finance its operations and other cash flow needs. As on May 31 2014, the company had not utilized any portion of the revolving credit facility. Therefore, it may choose to tap into these funds, if proven guilty and liable to pay the fine.

Revenue growth and margin improvements shall help recover losses from the penalty

FedEx’s operating profits have grown significantly in the past five years. Its operating profit increased 73.7% from fiscal year 2010 to fiscal year 2014 driven by revenue growth supported by the booming e-commerce industry and overall growth in world GDP. We believe that continued growth in the world economy and e-commerce industry will help drive FedEx’s revenues in the coming years.

IMF forecasts the world economic output to increase 3.6% in 2014 and 3.9% in 2015, compared to 3.0% in 2013. [4] Also, global e-commerce sales are expected to increase 20.2% in 2014 and 17.7% in 2015, to reach $1.77 trillion. [5] These trends will ensure continued growth in FedEx’s revenues. However, operating margins will play a key role in determining how much of the revenue growth trickles down to the bottom line.

FedEx’s operating margin increased from 5.8% in fiscal year 2010 to 7.6% in fiscal year 2014. We expect its operating margins to continue to improve, driven by the new dimensional weight pricing mechanism, which will be effective from January 2015 (Click here to read our article). The new pricing mechanism will not only help improve margins, but also help in revenue growth.

The potential future revenue growth and margin improvement should easily allow FedEx to recover losses from the penalty.

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Notes:
  1. FedEx Faces Additional Charges in Prescription-Drug Delivery Case, August 15 2014, online.wsj.com []
  2. FedEx 2014 Annual Report, www.fedex.com [] []
  3. UPS’s Q2 2014 10-Q SEC filing, www.sec.gov []
  4. World Economic Outlook, April 2014, www.imf.org []
  5. Global B2C Ecommerce Sales to Hit $1.5 Trillion This Year Driven by Growth in Emerging Markets, February 3 2014, www.emarketer.com []