Investors looking for a low-volatility Net play might find a good one here

BUSINESS AT NET SPEED Click for June 22, 1998 issue
By now, investors can find plenty of public companies that are direct plays on commerce done over the Internet. Bookseller (AMZN), music-CD purveyor N2K (NTKI), and online travel agent Preview Travel (PTVL) are just a few of the Internet stocks that have doubled or tripled in price this year -- despite the fact that they aren't expected to be profitable for a year or more. In recent weeks, Internet stocks have suffered a correction, confirming many investors' suspicions that a speculative bubble has been building in the sector. N2K, for example, traded around 13 in January, shot up to 34 in April, and closed on June 11 at 16 3/4.

If this kind of volatile high-flier doesn't fit your concept of prudent investing, plenty of established companies also stand to benefit from the growth in electronic commerce. Federal Express (FDX) is the favored "closet" Internet play of Karl Mills, a principal at Jurika & Voyles, an Oakland (Calif.) firm that manages $7 billion in institutional accounts and $250 million in three no-load mutual funds using value-oriented strategy.

Federal Express has been a pioneer in using the Web to better serve its own customers, and it has also played a significant role in helping customers move their businesses online. If electronic commerce fulfills even a fraction of its vast potential -- and if a huge numbers of ordinary folks start shopping from home -- the company's shipping volume should surge. With its strong brand name and technological lead, FedEx is poised to take a larger share of the delivery business than competitors UPS and Airborne Freight (ABF).

BITS TO BOXES. The image of E-commerce is of people going online to order what they want. But "at some point, all those bits turn into boxes," says Mike Janes, FedEx' vice-president for electronic commerce and logistics marketing. (With the acquisition of trucking company Caliber System earlier this year, Federal Express became a subsidiary of holding company FDX Corp.)

And when people start ordering online en masse, Mills thinks they will want those goods to arrive as fast as possible. "The Internet is about instant gratification," says Mills. "You want the thing now, and FedEx plays right into that."

FedEx' online retail accounts include L.L. Bean and Williams-Sonoma, but such shipments are only a fraction of its business. For now, the vast majority of shipments processed online are business-to-business transactions from the likes of Cisco (CSCO), Dell Computer (Dell), and Insight Direct, a direct marketer. FedEx now processes two-thirds of its 3 million shipments each business day through electronic networks, including its private networks and its Web site. With that kind of a percentage, "it's hard to disconnect our E-commerce strategy from our overall business strategy," says Janes.

Even before it generates more volume, FedEx's E-commerce strategy should cut costs. launched way back in November, 1994, to rave reviews because it allowed customers to track packages all over the world -- one of the first truly useful Internet applications. It now receives 1.7 million tracking requests per month, saving the company the cost of handling those requests through phone calls. (FedEx declined to give specifics on the savings.) With "FedEx interNetShip," launched in July, 1996, the shipper's customers can also arrange for deliveries through the Web by filling out an electronic airbill and printing out their own label.

LONG-TERM PLAY. Still, while Wall Street applauds FedEx's technological innovations, analysts are far from unanimous on the stock. According to First Call, of 12 analysts surveyed, four rate it a strong buy, three as a weak buy, six as a hold. Consensus earnings estimates for the company's 1998 fiscal year (which ended in May) are for $3.88 a share, up from $3.12 last year. In 1999, the company is expected to earn $4.31 per share.

Few analysts seem to have high hopes for its Internet strategy amounting to much over the next few years. "It's wonderful to talk about this stuff, and I imagine that over time they will become one of the airlines of the Internet," says John Pinkavage, an analyst with SBC Warburg Dillon Read. "But that doesn't do anything for the next couple of quarters or even the next couple of years. People are impatient these days."

Near-term, the company has plenty of non-Internet issues to contend with. It has to sign a new contract with its pilots; Teamsters are trying to organize its ground workers; and the Boeing 727s it flies may need costly repairs, says Stephen Klein, an equity analyst with Standard & Poor's. Other analysts are concerned about the effects of the economic crisis in Asia, where Federal Express generates roughly one-third of its revenues. UPS and Airborne have also been stiff competitors on pricing lately.

Ultimately, what concerns analysts most is whether FedEx can improve its profitability. A recent rise in two-day deliveries has hurt margins, says Steven Colbert, an analyst at Mills's firm. The company also needs to reduce the cost of delivering into the residential market -- especially if E-commerce booms. Its acquisition of trucking company Caliber could be a key to reducing those costs, Colbert believes. The stock fell sharply last September after the Caliber deal was announced (and as Asia's crisis worsened) because investors were concerned that FedEx was getting into a low-tech business, says Klein. The stock fell from a high of 84 to 55 by December. It recovered some of those losses early in the year and closed on June 11 at 61.

'NOSEBLEED LEVELS.' With so many looming concerns about the company, why buy FedEx and not one of the hot Internet stocks? "There is a little thing called valuation that gets in the way," Mills says. While other Internet plays are "at the nosebleed level," trading at multiples of anticipated future revenues (not earnings), FedEx is trading at only 15 times this year's earnings. That adds up to about a 30% discount to the rest of the market. "With lower valuations, there should be less risk built into the price," says Mills. He expects the company to grow at about 15% a year over the next three years.

Suzanne Betts, an analyst with Goldis-Pittsburg Institutional Services, raised her rating on FedEx to a buy on June 11 mainly because of its low valuation. She cut the stock to a hold back in March when it was trading at 73. The company had benefited from low fuel costs, but she was concerned then that those costs would rise by yearend. She was also concerned about price competition from UPS and the effects of economic problems in Asia. "Now the market has taken those things into account, and it has come back down into more of a buying range for us."

"The shareholder hasn't seen the benefit of a lot of the things the company has been doing," says Paul R. Schlesinger, an analyst at Donaldson Lufkin & Jenrette. "For the perceived quality of the brand name, the financial performance has not kept pace." But, for value investors who anticipate that FedEx' strategy will pay off, particularly its embrace of E-commerce, that's exactly why now could be a good time to buy in.

By Amey Stone, Associate Editor, Business Week Online


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Updated June 11, 1998 by bwwebmaster
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