FedEx Corporation (NYSE: FDX) generated an above average return on equity of 18.7% over the past twelve months, while the Industrials sector returned 10.1%. Even though FedEx’s performance is impressive relative to its peers, it’s useful to understand what’s really driving the company’s healthy ROE and how it’s trending. Understanding these components may change your views on FedEx and its future prospects.
FedEx’s Return On Equity
Return on equity represents the percentage return a company generates on the money shareholders have invested. Return on equity or ROE is defined as follows:
ROE = Net Income To Common / Average Total Common Equity
A higher return on equity suggests management is utilizing the capital invested by shareholders efficiently. However, it is important to note that ROE can be “manufactured” by management with the use of leverage or debt.
FedEx’s historical ROE trends are highlighted in the chart below.
source: finbox.io data explorer – ROE
It appears that the return on equity of FedEx has generally been increasing over the last few years. ROE increased from 6.9% to 12.6% in fiscal year 2016, increased to 20.1% in 2017 and decreased to 18.7% as of LTM Nov’17. So what’s causing the general improvement?
What’s Driving FedEx’s Improving Return On Equity
The DuPont analysis is simply a separate way to calculate a company’s ROE:
ROE = Net Profit Margin * Asset Turnover * Equity Multiplier
Created by the DuPont Corporation in the 1920s, the analysis is a useful tool that helps determine what’s responsible for changes in a company’s ROE. It highlights that a firm’s ROE is affected by three things: profit margin, asset turnover, and its equity multiplier or financial leverage.
Analyzing changes in these three items over time allows investors to figure out if operating efficiency, asset use efficiency or the use of leverage is what’s causing changes in ROE. Strong companies should have ROE that is increasing because its net profit margin and/or asset turnover is increasing. On the other hand, a company may not be as strong as investors would otherwise think if ROE is increasing from the use of leverage or debt.
So let’s take a closer look at what’s driving FedEx’s returns.
FedEx’s Net Profit Margin
It appears that the net profit margin of FedEx has generally been increasing over the last few years. Margins increased from 2.2% to 3.6% in fiscal year 2016, increased to 5.0% in 2017 and decreased to 4.7% as of LTM Nov’17.
Therefore, the company’s increasing margins help explain, at least partially, why ROE is also increasing. Now let’s take a look at FedEx’s efficiency performance to see if that is also boosting ROE.
FedEx’s Asset Turnover
It appears that asset turnover of FedEx has generally been increasing over the last few years. Turnover decreased from 1.36x to 1.22x in fiscal year 2016, increased to 1.28x in 2017 and increased again to 1.29x as of LTM Nov’17.
source: data explorer – asset turnover
Therefore, the company’s increasing asset turnover ratio helps explain, at least in part, why ROE is also increasing.
Finally, the DuPont constituents that make up FedEx’s ROE are shown in the table below. Note that the table also compares FedEx to a peer group that includes United Parcel Service, Inc.(NYSE: UPS), XPO Logistics, Inc. (NYSE: XPO), Air T, Inc. (NASDAQ: AIRT) and C.H. Robinson Worldwide, Inc. (NASDAQ: CHRW).
source: finbox.io’s DuPont model
In conclusion, the DuPont analysis has helped us better understand that FedEx’s general improvement in return on equity is the result of an improving net profit margin, an improving asset turnover ratio and increasing leverage. Therefore when looking at the core operations of the business, FedEx shareholders have reason to be excited due to the company’s general improvement in profitability along with a general improvement in operational efficiency.
The DuPont approach is a helpful tool when analyzing how well management is utilizing shareholder capital. However, it doesn’t necessarily tell the whole story. For example, how do the company’s ROE trends compare to its peers or sector? How about in absolute returns? I recommend that investors continue to research FedEx to gain a better understanding of its fundamentals before making an investment decision.
Author: Andy Pai
Expertise: financial modeling, mergers & acquisitions
Andy is also a founder at finbox.io, where he’s focused on building tools that make it faster and easier for investors to do investment research. Andy’s background is in investment banking where he led the analysis on over 50 board advisory engagements involving mergers and acquisitions, fairness opinions and solvency opinions. Some of his board advisory highlights:
- Sears Holdings Corp.’s $620 mm spin-off via rights offering of Sears Outlet, Hometown Stores and Sears Hardware Stores.
- Cerberus Capital Management’s $3.3 bn acquisition of SUPERVALU Inc.’s New Albertsons, Inc. assets.
Andy can be reached at email@example.com.
As of this writing, I did not hold a position in any of the aforementioned securities and this is not a buy or sell recommendation on any security mentioned.