2023-06-30 10:49:18 ET
Summary
- GXO has shown strong organic growth in all regions, particularly in Europe, and has a robust pipeline of $2.3 billion worth of opportunities.
- The company's defensive business characteristics, including long-term contracts and high revenue visibility, make it a relatively safer choice in the transportation sector for investors.
- If GXO meets its FY27 target, its market cap could reach $31 billion at 22x forward EBITDA multiple. However, the company must meet consensus expectations to maintain credibility.
Overview
GXO Logistics ( GXO ) is a leading pure-play contract logistics provider and should benefit from supply chain disruptions and a jump in e-commerce penetration. I continue to believe GXO is a buy at the current valuation as recent solid performance and high visibility into FY23.
Macro view
Management at GXO, in contrast to that of many other companies, has begun to put a more optimistic spin on macro comments. These comments are also backed by strong organic growth in every region it operates in. In particular, GXO Europe had a fantastic performance, which management attributed to the fact that the soft macro in Europe has troughed in 2H22. Given that I had anticipated Europe would soon enter a recession, I think this is a remarkable achievement. If Europe is able to pull itself out of its current macro situation and into recovery mode, it makes me wonder how strong GXO Europe performance can be. With a strong sales pipeline and transformational projects, management believes Europe is incrementally getting better in 2023. Besides Europe, I think it's worth noting that GXO's wage inflation has slowed to the mid-single digits, which is good news because it indicates a weakening labor market for the company and should help support/improve margins.
Strong pipeline
I see strong support for GXO's stock price in the near-term as there is very high growth visibility into FY23. To be more precise, GXO has won nearly $400 million in new business so far this year and should have secured over $800 million in incremental 2023 revenue YTD. These numbers alone suggest that GXO should have experienced revenue growth of around 9% so far this year, which is in line with consensus estimates. I expect the near-term valuation to be supported even further by the increased certainty surrounding FY23 and the clarity surrounding FY24's revenue pipeline. Currently, there are $2.3 billion worth of opportunities in the pipeline as of the end of the first quarter. I think it's important to pay attention to the quality of this robust pipeline because there should be more emphasis on first-time outsourcing business, which now accounts for a third of the pipeline. This tells me that GXO is winning a lot of shares, and these contracts have potential to turn into long-term recurring revenue, thereby improving visibility.
Defensive business characteristics
In addition, I believe that GXO's defensive features are highly valued by investors in the present business climate. Therefore, GXO appears to be somewhat of a "safe haven" for investors who want to put their money into the transportation sector. The idea that GXO's business fundamentals will be threatened by a downturn is currently circulating, which I see as a common misconception. Since GXO was originally a department of XPO before being spun off, I believe this misunderstanding originated there. GXO is not as cyclical as the typical transportation company; the company has continued to post high single-digit organic growth despite a challenging market. GXO has very high revenue visibility thanks to its contract model, which has average contract lengths of 5–7 years and high renewal rates. To highlight the resilience of the business model, it is worth mentioning that approximately 50% of GXO's contracts are open-book contracts, unaffected by decreases in volume, while the remaining 50% have established minimum volume requirements. Moreover, all contracts include inflation escalators incorporated into their terms.
Valuation
Given the high revenue visibility nature of GXO's business, I am confident that the company will be able to meet its FY27 target due to its resilience, strong and growing revenue base. With high visibility into FY23 and growing visibility into FY24 supporting the near-term valuation, I believe the market will gradually begin to price in FY27 data. This begs the question of how much GXO is worth if it achieves the FY27 results. If we add the current 22x forward EBITDA to the targeted $1.6 billion EBITDA, we get a market cap of $31 billion, or 4.5x the current market cap. This assumes that all FCF generated during the process is reinvested back into the business; however, returns could be even higher if capital return actions are included. Having said that, the journey to this $31 billion market cap will be gradual over the next few years.
Risks
The risk that shareholder faces is GXO meeting consensus expectations. A core part of GXO thesis in the near-term is visibility to revenue, as such, consensus and the remaining of the market have explicit expectations. This has also helped to build up the creditability of management words (i.e. guidance). If GXO fails to meet expectations, it would cast doubt on whether GXO's FY27 targets are reliable or plausible.
Conclusion
GXO demonstrates positive indicators that support the possibility of achieving its FY27 targets. With a strong and growing revenue base, high visibility into FY23, and a robust pipeline for FY24, the company is well-positioned for future growth. The defensive business characteristics, including long-term contracts and revenue resilience, make GXO an attractive investment in the transportation sector in my view. Additionally, GXO's recent performance and management's optimistic macro comments contribute to this.
For further details see:
GXO Logistics: Positive Indicators Support Possibility Of Achieving FY27 Targets