2024-01-02 03:10:08 ET
Summary
- XPO is a global transportation and logistics company with a heavy presence in LTL.
- With the exit of a major player in the industry, Yellow Corp, the company is seeing market share gains and pricing power.
- It recently bought 28 service centers as it goes through Chapter 11 and should benefit as its network expands.
- With a solid balance sheet and attractive valuation, XPO is a worthy addition to any portfolio.
Investment Thesis
XPO, Inc. ( XPO ) is a logistics and transportation company specializing in the less-than-truck-load ((LTL)) space. With the recent bankruptcy of Yellow Corp., XPO has been gaining market share which has enabled it to see growth in tonnage and shipment count. It has also been able to find temporary pricing power amidst the changing industry dynamics, which has translated to higher margins. Going forward, the company should be able to exceed its 2027 target of 600 bps of improvement in its adjusted operating ratio. With a solid balance sheet and a decent valuation at 12.6x forward EV/EBITDA, XPO shares look attractive today.
Company Overview
XPO is a global logistics company deriving 60.2% of its revenues from North America and the other 39.8% from Europe (mostly France and the UK).
In the US, XPO is one of the major players in the less-than-truck-load space, which is a shipping method used for transporting relatively smaller freight and cargo that doesn't require the use of an entire truck. In essence, this means that instead of paying for an entire truck when you don't need it, several smaller shipments from different senders can be combined and shipped together. This is good for senders as they save money compared to booking an entire truck for a smaller load. XPO's US network covers 99% of zip codes through 294 service centers and it serves 30,000 local and blue chip customers (e.g. Deere & Company (DE), Ford (F), 3M (MMM), and Caterpillar (CAT)). The average top 10 customer has been with XPO for 16 years, highlighting the strong relationships it has built over time.
On the European front, XPO is a market leader with diverse services including LTL, full truckload ((FTL)), truck brokerage, last mile, and freight forwarding. As a market leader, it operates the #1 position in France, Spain, and Portugal for FTL brokerage services and as an FTL provider.
XPO Geographical Footprint (Investor Presentation)
Business Strategy
Trucking is not an easy business. Unlike railroads , which have much more pricing power, trucking and logistics is a game of efficiency. As a capital-intensive business, there are few opportunities for companies within the space to set themselves out from the competition. Demand can also be cyclical, being tied to the overall ebbs and flows of the economy and broader macro environment.
However, LTL, which is XPO's bread and butter, is a little different. While also an asset-intensive business, LTL has barriers to entry for its industry that are a lot greater than those for other trucking and logistics services. For example, to build out a network that spans the geography of the US, it would take an enormous amount of time and investment to build out, not to mention the manpower and labor required, which can be tough in a tight labor market such as the one we see today. As such, LTL tends to have significantly fewer players than FTL for example, with the top 15 carriers in the space accounting for over half of the market. XPO's market share is around 8%.
Over the years, XPO has undergone a number of M&A transactions that have enabled them to become one of the best-in-class carriers in the trucking space. In 2013, XPO was largely a trucking brokerage company but decided to expand into other adjacent areas of trucking. This included getting into heavy goods last mile delivery, intermodal, and contract logistics. In 2015, with the acquisition of Norbert Dentressangle, XPO grew into the European market and also got into LTL with the acquisition of Con-way .
Over time, XPO integrated these acquisitions over time by becoming a more efficient operator. It shows up in the margins too, with EBITDA margins expanding from just 4.4% in 2015 to 11.3% in 2021 (S&P Capital IQ). This showed that XPO had successfully been able to transition into higher-margin businesses with greater pricing power and barriers to entry through its M&A strategy.
More recently however, as many acquirers tend to do over time as they become larger, XPO began to simplify its operations by spinning out its global contract logistics business through a separate public company called GXO Logistics ( GXO ) in August 2021. Through the formation of GXO, the new company became the #2 global player in the contract logistics business while XPO would primarily focus on its brokerage and LTL businesses. XPO also did another spinoff with RXO ( RXO ) the following year in November 2022, spinning out its intermodal segment and asset-light truck brokerage business.
In my view, these two spinoffs were prudent decisions by XPO as they gave both of the spinoff companies (and XPO) more focus on their independent operations and enhanced the flexibility of both companies' capital allocation decisions. After the spinoffs, XPO's LTL segment has become the primary source for both sales and free cash flow generation. Going forward, I wouldn't be surprised to see XPO spin out its European trucking segment in the future given the heavy focus on US LTL.
Recent Results
When looking at the latest earnings for XPO, sales for Q3 were up 2%, and adjusted EBITDA was up 6%. In commenting on the company's recent results, CEO Mario Harik, chief executive officer of XPO said:
In North American LTL, we’re improving every aspect of the business that impacts customer service and value creation. Our third quarter adjusted operating ratio of 86.2% improved sequentially by 140 basis points, and outpaced seasonality by 370 basis points. This was driven by gains in volume, pricing and labor productivity. Our damage claims ratio was a company-best 0.4% — a significant improvement from 1.2% two years ago, when we launched our LTL 2.0 plan.
Coming off a tough comp for last year, I'd say these results are pretty impressive and are aligned with the company's LTL 2.0 strategy which was laid out in 2021. This strategy includes targets for revenues and EBITDA growth, as well as efficiencies. By 2027, the company wants to see annual revenue growth between 6% and 8%, adjusted EBITDA growth of 11% to 13%, and improve its operating ratio by at least 6%.
Third Quarter Results (Company Filings)
The market for freight and logistics has been pretty tough recently. The broader macro environment has meant that one of XPO's competitors, Yellow Corp, has decided to exit the LTL market, filing for Chapter 11 bankruptcy. With Yellow Corp holding about an 8-9% market share, this meant that XPO has been able to pick up market share , seeing an annual increase in shipment count of 7.8%.
As well, with a major player leaving the industry, this also left room for XPO to pick up assets at fire sale prices. Last month, XPO was able to acquire 28 service centers (26 purchased outright, and assumed leases on the other 2) for $870 million from the bankruptcy in what CEO Mario Harik described as a " once-in-a-generation opportunity to increase capacity in critical, growing freight markets" which should enable the company to expand its network reach its customers more effectively. With 294 service centers before the announcement at quarter end, this grows XPO's service center count by about 10%.
I view the assets acquired as a good deployment of capital on XPO's part. Building off of the capacity investments in its fleet for 2023 (more than two-thirds of capex spend was invested into its fleet), XPO can now strategically expand its network reach and grow its operational capabilities. It's now guiding for capex of $700 million plus or minus $25 million, compared to the $500-$600 million guidance range previously. With fewer players in the LTL market, this bodes well for survivors like XPO as it increases the value of the current network effects.
The Yellow Corp bankruptcy has also meant that XPO now sees an opportunity for double-digit price increases over the next three years, in conjunction with its current opportunities of expanding ancillary, value-added revenues in local markets. In my view, with faster pricing increases, this likely means that the company's targets for 2027 will be exceeded and that we could see more than the 600 bps of operating ratio expansion previously set out.
Financials
With the bankruptcy of a peer, a discussion on XPO would be incomplete without taking a look at the company's financial position. At quarter end, XPO had $355 million of cash on its books with $589 million of available liquidity through borrowing facilities.
Excluding leases, the company had $2.4 billion in long-term debt, most of which was spread out pretty evenly in 2025, 2028, and 2031. This put its net leverage at 2.2x TTM EBITDA, a ratio that has been coming down over the years. With long-term debt making up just 20% of the company's enterprise value, I'm not worried about XPO's liquidity or solvency, given that it has a reasonable maturity profile and low leverage, which should allow it to continue to invest back into the business and grow its network.
In the bankruptcy of Yellow Corp, the company had a problem refinancing about $1.5 billion which was maturing in September 2024, most of which was as a result of a large $700 million government loan. At the time of the loan, Yellow Corp had a net debt to EBITDA ratio well over 6.0x, so it was clearly overleveraged (S&P Capital IQ). So to me, Yellow Corp's problems looked more systemic, rather than being symptoms of the industry.
XPO by contrast has been prudent with its leverage and never had the same problems Yellow had with unionized workers. This, coupled with XPO being more efficient with better EBITDA margins (compared to Yellow at around 4%), meaning that it survived the downturn between 2021 and 2022 when LTL shipments fell 17%.
Valuation
Based on the 19 equity research analysts with one-year target prices on XPO's stock, the average target price is $92.72, with a high estimate of $105.00 and a low estimate of $70.00. From the average target price, this implies about 5.9% upside from the current price.
When looking at the valuation for XPO, the company trades at an EV/EBITDA ratio of 16.8x. When excluding the period between mid-2020 to late 2021, the company is trading at the higher end of its historical range. However, on a forward basis, the forward EV/EBITDA ratio is around 12.6x, which seems a lot more reasonable.
At 12.6x forward earnings, consensus estimates are predicting 7.52% and 7.46% revenue growth for 2024 and 2025, respectively, with improving margins from 13.4% to 14.3% in 2024 and 15.4% in 2025. To me, this seems like a decent multiple to pay, especially when considering the opportunity here with Yellow no longer in the industry. Even without this, XPO has put up decent growth and margin expansion, which makes me confident about the business going forward.
When it comes to risks to my investment thesis here, the company's shares are up 163.1% for 2023, so they could be due for a near-term pullback, as some investors take profits. I'm a value investor, so if I'm getting a good price today, I try not to worry about what happened to the share price in the past. For company-specific risk, seeing as how unions were a contributing factor to the suffering of Yellow Corp, I would watch carefully how XPO engages with its labor force. Only a small number of XPO employees are unionized, partially in Europe and just 212 unionized workers in North America. In the past, XPO has had a good relationship with Teamsters , which is the union that represents many different unionized workers in rail, construction, and trucking. So in my view, this risk is somewhat minimized.
Conclusion
In summary, XPO stands as a leading force in global logistics, leveraging its strong foothold in North America and Europe, particularly in the less-than-truck-load space. Over time, the company has proven out decent margin expansion and has spun out two companies to become a more focused operator. Recent spinoffs have streamlined operations, emphasizing focus on LTL services while capitalizing on opportunities like acquiring assets from Yellow Corp's bankruptcy. In my view, I believe that XPO stands well-positioned to leverage the reduced competition, enabling it to explore price increases and grow revenues. With its strong financial position, XPO has a manageable debt profile, ample liquidity, and doesn't exhibit problems with its union, so I think the issues relating to the bankruptcy are company-specific, rather than characteristics of the LTL industry. In fact, given the current valuation, I'm more optimistic about XPO going forward and believe that shares look like a good addition to a well-diversified portfolio.
For further details see:
XPO: What The Yellow Corp. Bankruptcy Means For The Company