XPO - XPO: Riding Out The Storm Unlocking Endless Future Potential

2023-06-23 14:39:39 ET

Summary

• XPO, Inc. is expanding its network and operations to drive efficiency and growth, with a focus on enhancing customer service.
• Despite industry headwinds, XPO has gained market share and demonstrated strong execution, with a healthy balance sheet and attractive valuation.
• Long-term potential is promising, but caution is advised due to current price levels and economic conditions.

Introduction

While this might sound a bit cocky, I have to say that ever since I mainly focused on long-term investing, my biggest mistakes haven't been stocks that I bought but companies that I didn't buy.

One of them is XPO, Inc. ( XPO ) , formerly known as XPO Logistics before a number of successful spin-offs turned the company into a pure-play less-than-truckload ("LTL") player.

Despite tremendous economic weakness, XPO's stock price is trading at an all-time high. The company benefits from the expectations that come with its new COO (as discussed in my prior article ), its efficient operations, and good execution despite challenges.

In this article, I'll update my long-term bull case and explain how I'm dealing with this stock, as its risk/reward has become a bit unfavorable.

So, let's get to it!

XPO Is Expanding: ODFL-Style

XPO isn't as efficient as its peer, Old Dominion Freight Line ( ODFL ). So far, ODFL has been unbeatable when it comes to operating efficiencies.

That said, the stock market doesn't care about the current state of things. It cares about where we might be going.

In that case, the market is betting that XPO will turn into ODFL 2.0, which includes expanding its network to achieve superior customer service. ODFL's network is the core reason why it can achieve high customer satisfaction, leading to improved pricing power.

On June 22, FreightWaves reported that XPO completed its Salt Lake City terminal. The expansion, aimed at serving the Pacific Northwest market, includes the addition of 58 doors and 170,000 square feet of yard space. This expansion is part of XPO's ongoing multiyear plan to add 900 doors to its national network, bringing the total to roughly 15,000 doors by the first quarter of next year.

Furthermore, FreightWaves noted that XPO has actively expanded its operations, adding six terminals and 369 net new doors by the end of 2022.

The company is strategically focusing on increasing capacity to drive efficiency, growth, and returns. Dave Bates, the Chief Operating Officer of XPO, emphasized that the investment in the Salt Lake City facility will enhance customer service and support new business growth in a significant freight hub.

Please note that Mr. Bates was a cornerstone of efficiency gains at ODFL. Hence, it is no surprise that XPO is expected to use similar strategies with (hopefully) similar results.

XPO's Execution Is On Point

One major thing that was mentioned by FreightWaves is the fact that XPO is gaining market share, thanks to smaller declines in tonnage compared to some of the major less-than-truckload carriers in the industry during the first two months of the second quarter.

So far, numbers for the month of May confirm that weakness is limited.

LTL tonnage per day declined 2.3%, as compared with May 2022, attributable to a year-over-year increase of 1.8% in shipments per day and a decrease of 4.0% in weight per shipment.

With that said, looking at the Logistics Managers' Index, we see a steep decline that started in early 2022. In May, the index went below 50. This shows severe industry headwinds.

On top of that, companies in the industry are rapidly losing pricing power. The chart below displays the pricing component of the Logistics Managers' Index.

Not only are prices weaker, but they have also fallen off a cliff in the past 12 months, mainly caused by declining transportation demand, as companies started to de-stock their inventories. After massive investments in new trucking capacities after the pandemic, the industry is now faced with slower demand and higher supply.

According to the LMI :

As logistics prices come down and eventually moderate we could see inflation continue to moderate, which may lead to a slowdown in interest rates and eventual recovery in the freight market. It appears that we will have to hit the bottom before a rebound can occur. The questions now are where that bottom is, and whether or not we are getting close to it?

With that said, XPO is doing two things:

• Growing in a challenging macro environment.
• Adjusting its company for long-term growth (like expanding its physical footprint).

In the first quarter of 2023, XPO reported total company revenues of $1.9 billion, showing a 1% increase compared to the same period last year and a 4% increase sequentially from the fourth quarter.

• The North American LTL business experienced a 1% year-over-year revenue growth and a 2% sequential growth.
• Revenue per hundredweight, excluding fuel, rose by 1.4%, offsetting the impact of lower tonnage with higher shipments per day.

LTL salaries, wages, and employee benefits were 6.7% higher than the previous year due to wage increases granted to employees in the prior year.

However, XPO implemented measures to reduce labor costs and improve productivity throughout the year.

Purchased transportation expenses decreased by 27% or $37 million as the company brought more third-party linehaul services in-house.

With that in mind, XPO's adjusted EBITDA for the entire company grew by 14% year-over-year to $210 million. This increase was mainly driven by a $31 million decline in corporate expenses as part of the company's efforts to streamline its cost structure after the RXO ( RXO ) spin-off.

• The adjusted EBITDA margin improved by 130 basis points, reaching 11%. The adjusted EBITDA for the LTL segment was $182 million, a decrease of 2% compared to the previous year, primarily due to lower tonnage, wage inflation, and lower pension income.

The adjusted operating ratio fell below 90%, which indicates higher operating efficiencies.

Furthermore, as part of the company's growth plan, LTL 2.0 saw strong progress in key areas.

• The company focuses on incentives for employees that align incentives with service quality. This initiative, along with others, resulted in improved customer service metrics. The claims ratio for damages decreased to 0.7% from 1.1% last year, and on-time performance returned to pre-COVID levels.

• The company plans to increase its capital expenditures to 8% to 12% of revenue on average over the next several years. This includes boosting investments in new terminals.
• The company's yield increased. As we already discussed, XPO became more efficient, despite headwinds. Related to that is the fourth point.
• In 1Q23, purchased transportation costs were lowered by 27% compared to the previous year. This reduction was achieved by capitalizing on favorable market conditions through proactive bid cycle management and reducing third-party linehaul miles.

XPO also plans to align the field cost structure with the current demand environment and reduce salaried headcount, with the full benefit expected to be realized starting in the third quarter.

On a long-term basis, XPO expects to lower its operating ratio by 600 basis points by 2027 with compounding adjusted EBITDA growth of 11% to 13%.

While the company cannot influence economic conditions, its LTL 2.0 program seems to be the perfect foundation for success.

Valuation & Balance Sheet

The company has a very healthy balance sheet.

XPO ended the first quarter with $309 million in cash and $811 million in total liquidity, including available capacity under committed borrowing facilities.

The company had no borrowings outstanding under its ABL facility, and the net debt leverage ratio at the end of the first quarter was 2.2x adjusted EBITDA.

Furthermore, XPO extended its EUR 200 million securitization facility in Europe to July 2026 and is evaluating opportunities to refinance its term loan maturing in 2025 with new secured and/or unsecured debt.

Thanks to its healthy balance sheet, its credit rating has been raised from BB+ to BBB-.

XPO is trading at 9.4x NTM EBITDA, which is very attractive.

However, XPO is trading at its target price of $52.

I agree with that target price. While I believe that XPO has tremendous long-term potential, I'm not willing to chase the price at current levels.

While I have to admit that I also didn't expect the stock price to soar this much, I am not comfortable buying a large stake in a transportation company without getting some kind of confirmation from bottoming leading indicators.

Hence, I will give the stock a neutral rating to reflect the risk/reward and economic environment.

On a long-term basis, I remain bullish and will adjust my rating the moment the stock price comes down (better risk/reward) or economic growth bottoms.

Personally, I hope that the stock comes down, as I want to own a piece of it.

Takeaway

In my journey as a long-term investor, I've come to realize that my biggest regrets lie not in the stocks I've purchased but in the investments I've missed.

One such missed opportunity is XPO, formerly known as XPO Logistics. Despite the economic weakness, XPO's stock price has reached an all-time high, driven by the company's new COO, efficient operations, and successful execution.

XPO aims to expand its network and emulate the success of Old Dominion Freight Lines, known for its superior customer service.

Recent expansions and active operations growth indicate XPO's strategic focus on enhancing capacity and driving efficiency.

While the industry faces headwinds, XPO has managed to gain market share and maintain stable numbers. The company's adjusted EBITDA and operating efficiencies demonstrate its positive trajectory.

XPO's healthy balance sheet and attractive valuation make it an enticing investment.

However, caution is warranted, given the current price level and economic conditions.

As an investor, I remain optimistic about XPO's long-term potential but will wait for more favorable risk/reward dynamics or economic recovery before adjusting my rating.

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