FedEx Just Spun Off Its Freight Division. Which Stock Should You Own?

In June, FedEx (NYSE: FDX) spun off an 80.1% stake in FedEx Freight (NYSE: FDXF), marking the start of the delivery giant's divestiture of its less-than-truckload (LTL) freight segment. Since the spinoff, both stocks have gone in different directions.

While shares in FedEx Freight's former parent have largely remained in a narrow range during the summer, FedEx Freight shares initially experienced a big rally, only to give back those gains, and then some.

Investors at the time of the spinoff received one share of FedEx Freight for every two shares of FedEx. The question now is whether it's time to exit both transportation stocks, keep one and sell the other, or let them both ride, viewing them as top industrial stocks.

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Is FedEx transforming into a lean, mean, parcel-delivering machine?

The spinoff isn't the only way FedEx has pivoted toward its core parcel delivery business. Last month, the company also announced the sale of its FedEx Supply Chain subsidiary. FedEx still owns 19.9% of FedEx Freight. It plans to divest the remaining stake either through exchanges of debt for common stock and/or by distributing them to shareholders.

Yet while FedEx still has skin in the game, management's focus now shifts toward executing its Network 2.0 strategic initiative. For customers, Network 2.0 represents a streamlining of FedEx's parcel pickup and delivery, but for shareholders, the main focus is the estimated $2 billion in structural cost savings.

Yet while long-term forecasts call for double-digit percentage earnings growth in 2027 and 2028, doubts remain. Fuel surcharges helped to mitigate the impact of soaring energy prices, but Amazon's move into the third-party logistics and shipping sector represents a major competitive threat to FedEx. Amazon is using tactics such as lower rates to gain market share.

Only time will tell whether Amazon affects FedEx's earnings growth, but keep in mind how success with Network 2.0 may already be baked into the stock's valuation. Right now, FedEx trades for 16 times forward earnings, a modest premium to rival UPS's forward multiple of about 14. For FedEx's efforts to translate into major gains in the stock, Network 2.0 needs to meet or exceed cost-reduction expectations. The company also needs to maximize customer retention amid the rising competition from Amazon.

Long-term FedEx investors may still want to sit tight. However, for anyone entering or adding to a position, you may want to wait for the next wave of turbulence.

FedEx Freight and its heavy "show me" discount

As an LTL freight-hauling company, FedEx Freight competes with companies like Old Dominion Freight Line. LTLs ship partial truckloads of goods for smaller industrial customers over shorter distances. The big opportunity for FedEx Freight lies in its discounted valuation.

Currently, FedEx Freight trades for about 25 times forward earnings. Competitor Old Dominion, on the other hand, trades for roughly 36 times forward earnings. Closing this valuation gap would mean major price appreciation for the stock.

However, don't expect FedEx Freight's valuation to rise simply because more investors are noticing this valuation discrepancy. It exists because Wall Street wants to see the company knock it out of the park in the coming quarters.

Much of this depends on the newly public company's execution, but external factors could also make or break the story. After softening, demand for LTL services is making a slow recovery. There's also the overhang of FedEx's eventual divestiture of its 19.9% stake. Depending on how quickly FedEx sells these shares, this could continue to weigh on FedEx Freight's performance.

Add in the fact that FedEx Freight also faces a competitive threat from Amazon, the key factor in the stock's initial post-rally pullback, and it's clear why Wall Street's staying in "show me" mode for now. Although a sentiment change would mean tremendous upside from current prices, consider waiting for concrete evidence that the situation is improving.

Thomas Niel has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Amazon, Old Dominion Freight Line, and United Parcel Service. The Motley Fool recommends FedEx and FedEx Freight Holding Company. The Motley Fool has a disclosure policy.