144% Potential Trade After FedEx’s Ugly Year

With holiday shopping season in full bloom, companies like FedEx are coming into the spotlight. After the unexpected changeup in leadership, the transportation leader’s stock has fallen through the floor.

As you can see, 2018 has been a real mess for the company:

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The question is: how did it get so bad?

The main reason is the fear over the trade war. With so much of its revenue coming from its global operations, many investors fear the company is in a terrible position to deal with the uncertainty of tariffs and the geopolitical landscape.

This isn’t the only problem FedEx has been dealing with however. With the rapidly increasing competition from Amazon’s own delivery service, the long-term outlook for FDX just isn’t as bright to most investors.

Rival UPS’s own recent slide, albeit less ugly than FDX’s, confirms that the main issues are on the industry level, rather than internal corporate problems.

That’s not to say there aren’t any problems with how FedEx is managing its own operations. As we alluded to, the company has made some upper management moves investors haven’t liked. The president and CEO of FedEx Freight, Michael Ducker, retired out of the blue earlier this year. That was accompanied with changes of his own at the COO level for the division.

Fast-forward to now. Last week, CEO of FedEx Express David Cunningham announced his retirement at the end of the year. That certainly seems like a fast and unexpected time table for a company in its busiest season. Many believe he’s being pushed out.

Whatever the reasons for these departures, investors aren’t happy. With the ensuing selloff, shares of FDX are now trading back below $200 for the first time since early 2017. Will they stay there? That’s the real important question.

More Than Meets the Eye

As one of the largest companies in a relatively safe industry, it’s rare to see such sharp declines. But 2018 has been that way for others. Nonetheless, are the worries investors have shown over FedEx’s business enough to warrant such a decline?

To answer that, you first need to look at the numbers. If the company’s financials match the same declining trajectory, then it might just be one play to avoid. But that’s not the case.

Revenue has been straight up for a long time. Last year, the company brought in $65.5 billion in sales. Just six years ago, it was only grossing $42.7 billion

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That’s a compound annual growth rate of 7.4% — not too shabby for such a large blue chip.

That has translated into higher bottom lines as well, which have more than quadrupled over the last four years. That, to be fair, was certainly helped by the recent tax cuts and may not be permanent.

As for shorter-term numbers, FedEx’s quarterly earnings have beat expectations each quarter this year, except the most recent. That was one reason for the most recent stock decline. But in that same earnings announcement, the company beat revenue expectations and raised its forward guidance. So, even in a bad quarter, there’s much to like.

The recent slide in share price has pushed its valuation extremely low. FDX now trades at just 0.8 times its sales and 16.4 times its earnings. With 2019 expected to be an even better year, it is trading at just 9.6 times its forward earnings.

Fortunately for the shipping giant, it is entering just the right time of year. With holiday shopping and a new earnings announcement next week, any good news should return many investors to the company’s stock.

A Strategy to Play FedEx’s Short-Term Strength

Buying shares of FDX might be a reasonable way to get into the company’s likely bounce back. But there’s no denying it, investors still do not like FedEx right now. There’s just no telling how long that sentiment will last.

Alternatively, you could simply pick up a call option to opt into gains with limited money down. But that results in a 100% loss in the event investors take too long to get back on the FedEx train. And right now, those options are a bit pricey following such a sharp decline.

Instead, you could enter a bull call spread. This is a type of option trade which requires the trader to buy a call like above. But he then also sells a call with a higher strike price.

The way it works is that you still profit if shares go up. But the cost to enter the trade is reduced by the amount made off the sold call.

This does limit the amount one can make on a sharply rising stock. But in FedEx’s case, a simple turnaround is more likely than some kind of miracle climb from here.

Here’s how a trade like that looks:

bullcallspread

Source: The Options Industry Council

Let’s take a look at a specific bull call spread trade on FedEx…

A Specific Trade on FDX

If a trader were to buy a January 19 $190 call for $8.05 per share and sell a January 19 $195 call for $6, his bull call spread would cost $2.05 to enter. Since each contract is worth 100 shares of FDX, that’s a net debit of $205.

That’s the most that trader would have at risk for the whole duration of the play… all the way to January 19’s expiration. That date is a good choice for this trade because of all that has to happen by then. Not only will FedEx have its earnings announcement next week, the holiday season will finish and politics will certainly create some volatility in early 2019. That could jostle companies like FDX around. It would just need one of those to go well and it could easily trade for more than $200 again.

The maximum profit for this specific trade is found by taking the difference in strike prices ($195 – $190 = $5) and subtracting the cost to enter the trade ($5 – $2.05 = $2.95). Again, each option represents 100 shares. So, the maximum profit would be $295.

That’s a 144% return on the amount of money one has at risk with this trade. For a company this large, we rarely see such opportunities.

— The Option Specialist

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About the Author: The Option Specialist