S&P Affirms FedEx Credit Ratings

The rating agency says the package-delivery giant should be able to achieve benefits from its Kinko's acquisition fairly quickly

On March 23, 2004, Standard & Poor's Ratings Services assigned its 'BBB' rating to FedEx Corp.'s (FDX ) $1.6 billion debt offering, issued under Rule 144A. The debt offering consists of three tranches: $600 million due 2005, $500 million due 2007, and $500 million due 2009. Standard & Poor's existing ratings on FedEx, including the long-term 'BBB' corporate credit rating and 'A-2' commercial paper ratings, are affirmed. The outlook is stable.

Proceeds from the debt offering will be used to repay commercial paper incurred to complete the acquisition of privately held Kinko's Inc. last month. Memphis, Tenn.-based FedEx currently has about $13 billion of lease-adjusted debt.

Standard & Poor's assessed the potential benefits and risks of the Kinko's transaction, as well as the likely time frame for paying down the acquisition-related debt, and determined that FedEx should be able to restore its financial profile and achieve benefits from the transaction fairly quickly. Although debt levels have increased as a result of the acquisition, FedEx is expected to generate sufficient earnings and cash flow to reduce debt leverage back to acceptable levels within the coming year.

In addition, ratings assume that incremental earnings and cash flow from the acquisition will more than offset costs associated with the integration and that the acquisition will enhance FedEx's competitive position. Ratings reflect expectations that adjusted funds from operations-to-debt will average 25% to 30% and that debt-to-capital (adjusted for operating leases), currently about 60%, will trend down to the mid- to upper-50% area.

FedEx is a holding company that, prior to the Kinko's acquisition, operated three major operating companies: FedEx Express, FedEx Ground, and FedEx Freight. Kinko's is now FedEx's fourth main operating company. Ratings on FedEx reflect its strong competitive position, offset by an ongoing need to fund substantial capital expenditures.

Main operating unit FedEx Express--the founder and still-leading participant in the air express segment of the domestic package express industry--dominates the company's business and financial profile. FedEx has been expanding its product line in recent years to offer its customers a full range of transportation and logistics services. Cross-selling of the portfolio of services, particularly to small and medium-sized businesses, is a key component of FedEx's growth strategy. The acquisition of Kinko's, which provides printing and other business services and generates about $2 billion in annual revenues, should enable FedEx to offer its shipping services in all of Kinko's 1,200 retail locations. FedEx has had a relationship with Kinko's for 15 years and currently operates full-service, staffed counters in 134 Kinko's locations.

The acquisition will diversify FedEx's revenue base and enable it to benefit from expected growth in Kinko's document management and outsourcing services and international expansion. However, it also exposes FedEx to acquisition-related risks, including the challenges of learning a new business and integrating operations. Most of Kinko's management team is expected to remain in place, which should help mitigate these risks. In addition, FedEx has integrated its recent acquisitions successfully.

Liquidity: Prior to the acquisition, FedEx had ample liquidity, with about $1 billion in cash on hand. It used a portion of the cash to fund the Kinko's acquisition and used commercial paper to fund the rest. At February 29, 2004, cash totaled $475 million and $1.9 billion of commercial paper was outstanding. FedEx recently entered into a $2 billion bridge facility maturing in August 2004 to back up the commercial paper used to fund the Kinko's acquisition. The commercial paper will be repaid with proceeds from the new debt offering.

FedEx also has $1 billion in revolving bank credit facilities, comprised of two parts. The first part provides for $750 million through September 2006 and the second part provides for $250 million through September, 2004. The revolving credit agreements contain covenants and restrictions typical for these types of agreements, including a leverage covenant and a fixed-charge coverage covenant. FedEx was in compliance with covenants as of February 29, 2004, and is expected to remain in compliance.

Outlook: The outlook is stable. While the Kinko's acquisition has caused financial risk to increase over the near term, prospects for improved earnings and cash flow, benefits from the acquisition, and management's commitment to reducing debt will enable the company to restore financial measures over the near to intermediate term. Current ratings incorporate no room for additional significant acquisitions or investments until the Kinko's acquisition is digested and the company begins to show benefits from the transaction.

From Standard & Poor's RatingsDirect

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