Fitch Ratings Initiates 'BBB' IDR For FedEx; Outlook Stable.

CHICAGO -- Fitch has initiated rating coverage of FedEx Corp. (NYSE: FDX) and its Federal Express Corp. subsidiary with the following ratings:

FedEx Corp.

-- Issuer Default Rating (IDR) 'BBB';

-- Senior unsecured 'BBB';

-- Unsecured credit facility 'BBB';

-- Short-term 'F2'.

Federal Express Corp.

-- Issuer Default Rating (IDR) 'BBB';

-- Senior unsecured 'BBB'.

The senior unsecured ratings apply to approximately $2.01 billion in outstanding debt obligations. The Rating Outlook is Stable.

The ratings for FedEx Corp. (NYSE: FDX) and its Federal Express Corp. subsidiary reflect the transportation company's relatively strong operating performance, improving margins, consistent free cash flow generation and manageable cash obligations. Although growth in FedEx Express' U.S. delivery volumes has been slowing over the past several years, FedEx Express' International Priority volumes, as well as volumes in the FedEx Ground and FedEx Freight segments, continue to show solid growth. On top of continued volume growth, pricing remains strong, as heavy demand has provided FedEx with the opportunity to raise base rates and offset higher fuel costs with surcharges. FedEx Kinko's performance is lagging the other business segments, however, as waning demand for its copying and printing services is pressuring revenue growth and continued integration costs are driving margins downward. FedEx Kinko's is the smallest of FedEx's business segments, producing only about 6.5% of the company's consolidated revenue, which limits the effects of that segment's weakening performance on FedEx's consolidated results.

Currently, FedEx's primary focus is on growing FedEx Express internationally, in addition to continued strengthening of its U.S. ground and freight businesses. International growth has been bolstered by FedEx Express' new "around-the-world" flights that have made use of the unit's recently-obtained rights to fly between the U.S. and China. FedEx Express has broken ground on a new hub in Guangzhou, China, that will replace its hub in Subic Bay, Philippines, once open in 2009. FedEx Express also plans this year to purchase the remaining 50% of FedEx-DTW International Priority, a Chinese express delivery joint venture, for $400 million, making that company wholly owned by FedEx Express. With these investments, FedEx is positioning itself to take advantage of growing demand strength within China and between China and other parts of the world, which will help to offset the slower growth in U.S. express delivery volumes.

FedEx's liquidity position is strong, with $1.94 billion in cash on hand at May 31, augmented by access to a $1 billion revolving credit facility. Operating cash flow is expected to remain robust in fiscal 2007, with favorable pricing and the company's focus on increasing productivity combining to drive continued margin improvement. However, calls on FedEx's operating cash flow will be heavy during the fiscal year, as FedEx Freight closes its $780 million acquisition of Watkins Motor Lines and FedEx Express closes the FedEx-DTW acquisition in China. FedEx also expects to spend approximately $2.9 billion on capital expenditures in fiscal 2007, most of which will fund various growth initiatives. On top of its acquisition and capital spending plans, the company has $850 million in debt maturities and capital lease obligations coming due in fiscal 2007, and in June, the company raised its dividend by 12.5%, increasing its annual cash dividend expense to an estimated $110 million. Fitch expects that FedEx will have sufficient liquidity to cover its cash obligations in fiscal 2007 without additional borrowing, provided the macroeconomic environment remains favorable.

After borrowing to fund the Kinko's acquisition in February 2004, FedEx has used its free cash flow to reduce debt over the past two years. Total balance sheet debt fell to $2.44 billion at the end of fiscal 2006 from $3.58 billion at the end of fiscal 2004. Over 80% of FedEx's balance sheet debt is unsecured, with capital leases and a small amount of secured debt making up the remainder. FedEx has significant off-balance sheet obligations, however, in the form of operating leases. In fiscal 2006, operating lease expense totaled $2.16 billion, equating to an off-balance sheet obligation of $17.31 billion. Although lease expenses and the resultant off-balance sheet obligations have risen with the company's growth, adjusted leverage has fallen as FedEx's financial performance has steadily improved, with adjusted debt to EBITDAR falling to 2.9 times (x) at the end of fiscal 2006 versus 3.5x at the end of fiscal 2004 and 3.7x at the end of fiscal 2001. Looking ahead, Fitch expects adjusted leverage to improve further in fiscal 2007, as margins show modest growth and the company pays down its debt maturities and capital lease obligations.

The package delivery and freight transportation industries are capital intensive, with significant investments needed in aircraft, trucks, facilities and other equipment. Between fiscal 2002 and fiscal 2006, FedEx's consolidated capital spending ranged between $1.62 billion and $2.52 billion, equal to about 8% of the company's annual revenues, and relatively higher than UPS's capital spending, which has been closer to 5% - 6% of annual revenue. For fiscal 2007, FedEx's full-year capital spending is estimated to be $2.9 billion, an increase of 15% over fiscal 2006 spending. About 75% of FedEx's planned 2007 capital spending will cover growth initiatives across the four business segments. The company plans a number of capacity additions to the FedEx Express, FedEx Ground and FedEx Freight networks, as well as technology investments aimed at increasing productivity. FedEx also plans to begin a multi-year program to increase the number of FedEx Kinko's locations, with 200 new locations planned in fiscal 2007.

In addition to its debt and lease obligations, FedEx has obligations tied to its defined benefit (DB) pension plans. These plans cover employees hired on or before May 31, 2003. As of May 31, 2006, FedEx's plans were 83% funded on a projected benefit obligation (PBO) basis, with a benefit obligation of $12.15 billion and total assets of $10.13 billion. FedEx voluntarily contributed $456 million to its DB plans in fiscal 2006, and the company estimates that it will make voluntary contributions in a similar amount in fiscal 2007. FedEx estimates that fiscal 2007 pension expense will approximate its cash pension contribution.

The most significant concern going forward centers on the cyclical nature of the express delivery and freight transportation industries, as their fortunes generally rise and fall with the strengthening or weakening of the macroeconomic environment. Several mitigating factors could limit the effect of a future downturn on FedEx's results, however. As FedEx's operations have become increasingly global in scope, the company has diversified away some of its exposure to changes in the U.S. economic environment, although it has also become more exposed to economic changes outside the U.S. Other mitigating factors include consumers' shift toward increasing use of online retail websites, which will likely benefit FedEx Ground, and consolidation within the LTL trucking industry that could help FedEx Freight weather an economic slowdown. In the event of a severe economic slowdown, FedEx could also reduce its discretionary capital spending to maintain liquidity. It is notable that FedEx generated positive free cash flow throughout the last economic downturn of 2001 - 2003.

Other concerns include FedEx's penchant for making acquisitions, as well as labor issues that could drive up personnel costs. The FedEx Ground, FedEx Freight and FedEx Kinko's segments were all formed through acquisitions and, as the recent Watkins and FedEx-DTW announcements have shown, the company continues to look for strategic acquisition opportunities. FedEx has generally been successful in integrating its acquisitions, however, and, outside the U.S., well-chosen acquisitions could be the most efficient way to grow the FedEx brand quickly. On the labor front, FedEx Express is in the midst of contract negotiations with its pilots, represented by the Air Line Pilots Association (ALPA), that will likely result in increased pilot labor costs once the company and ALPA reach a new agreement. FedEx Ground is also working through labor-related matters, as the unit is involved in several lawsuits related to whether or not its independent contractors should be reclassified as company employees. Not only would rulings against FedEx in the FedEx Ground cases potentially increase labor costs, but the International Brotherhood of Teamsters (IBT) has stated its intention to increase its efforts at organizing FedEx Ground's employees should FedEx lose the cases. However, with the exception of ALPA, efforts to organize labor at FedEx have generally been unsuccessful in the past.

Fitch's rating definitions and the terms of use of such ratings are available on the agency's public site, 'www.fitchratings.com'. Published ratings, criteria and methodologies are available from this site, at all times. Fitch's code of conduct, confidentiality, conflicts of interest, affiliate firewall, compliance and other relevant policies and procedures are also available from the 'Code of Conduct' section of this site. The ratings above have been initiated by Fitch as a service to investors. The issuer did not participate in the rating process other than through the medium of its public disclosure.