FedEx Corp (FDX) disappointed investors yesterday with a profit drop and significantly lower revenue and earnings guidance. However, the stock is now cheap and is attracting attention from value and contrarian investors.

FDX stock is at $258.82 in midday trading on Friday, Sept. 20, down over $41. That represents a drop of -13.8% from the prior close. Moreover, this is close a 3-month low on June 21 of $253.66.

FedEx said its outlook now shows revenue will be lower than expected with a “low single-digit growth rate” year-over-year. They also lowered earnings expectations for the year ending May 2025. As a result, analysts have lowered their earnings per share (EPS) estimates.

For example, the company expects FY 25 adjusted EPS of $20 to 21. So, today's price puts FDX stock on a forward multiple of about 12x earnings (i.e., $259/$21 = 12.3x). In addition, its annual dividend per share (DPS) of $5.52 gives investors a yearly 2.1% dividend yield.

Value Investors and Contrarians Gather Around

This is attracting value investors and contrarians. After all, the company is still very profitable. FedEx is still generating large amounts of free cash flow (FCF). 

In fact, FedEx's earnings presentation shows on page 9 that it expects to generate $3.8 billion in adj. FCF. That works out to about 4.3% of analysts' forecasts of $89 billion in revenue for the year ending May 2025.

This implies that next year, using analysts' $93.44 billion in revenue expectations, FCF could rise to about $4.02 billion in adj. FCF (i.e., 0.043 x $93.44 billion). That represents growth of 10.6% over the $3.8 billion expected by FedEx this fiscal year.

Price Targets for FDX Stock

As a result, FDX stock could be worth at least 15% to 27% more. For example, using a 5.5% FCF yield (it's 6.0% now), FedEx Corp could eventually have a market cap of $73 billion. That is $10 billion more than its $63.3 billion market cap today, or 15.5% higher. 

This sets the near-term price target at $299 per share (i.e., 1.155 x $259). Moreover, with just a slightly better FCF yield of 5.0%, the stock's value rises to $80.4 billion, or 27% more. That sets the price target at $329 per share.

This could be why analysts have higher price targets. For example, the average of 26 analysts surveyed by Yahoo! Finance is $322.09 and $322.96 at Barchart. Moreover, AnaChart.com reports that 27 analysts have an average $347.98 price target.

One way to play this is to sell short deep out-of-the-money (OTM) put options in nearby expiry periods. That way the investor can make extra income while setting a lower buy-in price.

Shorting OTM Puts

For example, look at the Oct. 11 expiration period, three weeks from today. It shows that the $240 strike price, almost 7% below today's price, has a bid-side premium of 70 cents. That represents an immediate short-put yield of 0.29%.

In addition, the $245.00 strike price, almost 5% below today's price, has a bid premium of $1.16. That represents a short-put yield of 0.47% (i.e., $1.16/$245.00).

This means that an investor who secures $24,500 in their brokerage account can “Sell to Open” one put contract at $245 and receive $116.00 immediately. Over the next quarter, if that is repeated the investor has an expected return (ER) of 1.89% during that period (i.e., $245 x 4, or $980/$24,500).

Moreover, the breakeven price is lower at $245-$1.16, or $243.84, which is 5.85% below today's price.

This works best for investors who want to set a lower buy-in price target, but won't be too upset if the stock doesn't fall to that level in the next 3 weeks. They would be happy to just collect that income. For existing investors, it represents a way to gather more income which could offset any unrealized losses from today's drop.

The bottom line is that FDX stock looks undervalued here and one way to play this is to sell short out-of-the-money put options in nearby expiry periods.

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On the date of publication, Mark R. Hake, CFA did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.