XPO’s healthy earnings: Merrill reiterates its buy rating

The strong earnings report Wednesday of XPO Logistics got positive reviews from analysts at Bank of America Merrill Lynch, with the company reiterating its Buy rating on XPO stock with a target of $100.

The logistics, LTL and brokerage company surpassed numerous street estimates in multiple categories. Its adjusted EPS of 45 cts/share was up 86% from the corresponding quarter of 2016. It was less than Merrill’s 50 cts estimate but above a street consensus of 44 cts. Revenue growth year-on-year was also strongly higher, with the brokerage business up 33% year-on-year, LML up 21% year-on-year, and contract logistics up 13%.

Merrill’s summary of the conditions that drove that numbers were macroeconomic in nature, with few specifics to XPO. “Growth was driven by rising truck spot rates and fuel surcharges (primarily benefitting Brokerage), favorable FX impacts (Europe), new customer wins, share gains, and e-commerce growth (primarily benefiting Last Mile and Logistics), and a stronger demand environment (benefiting all segments),” Merrill said in its report.

XPO said in its earnings report that LTL margins were the highest in 12 years, but the Merrill report said “they still trail best-in-class peer ODFL by a wide gap, suggesting there’s more work to be done in culling unprofitable accounts and driving yield growth.”

From its recent high close of $98.37 on January 23, XPO’s stock fell to $86.41 before closing Wednesday at $90.01. That decline from January 23 represented an approximate 8.5% decline. By contrast, the S&P 500 during that time was down approximately 5.5%. In Thursday’s sharp decline, XPO declined to just over $85 before rebounding to $87.36 at 3:10 p.m.

XPO is a company that has grown both organically and through acquisitions, pulling back somewhat on the latter strategy in the past 1-2 years. Merrill analysts Ariel Rose and Ken Hoexter, in their report, said they expect acquisition activity this year, but that organic growth remains strong. “While we continue to expect XPO to pursue an acquisition in 2018, its organic revenue growth in excess of 10% and its robust pipeline of $3.2 billion, as well as ongoing margin improvement efforts, should support earnings and cash flow growth,” they wrote.

In reiterating the $100 price target, Merrill said it is based on a 10.5x EV/EBITDA multiple of what Merrill estimates will be 2018 EBITDA of $1.61 billion and earnings per share of $3.15. The company’s EPS in 2017 was $1.95, but that was after charges, including $173 million related to tax reform. On a GAAP basis, EPS was $2.45 in 2017, with Merrill projecting GAAP EPS in 2018 of $2.73.

Stock market targets and valuations are not the same thing, and for XPO, that’s clear in the Morningstar Fair Value Estimate—a proprietary Morningstar term–for the company of $59. That is up from $47. “We caution that the shares are trading in overvalued territory, suggesting investor expectations may have swayed a bit too far to the optimistic side–a common theme across our trucking and logistics coverage universe,” analyst Matthew Young said in a report issued after the earnings release.

Morningstar’s definition of Fair Value Estimate is succinct: It is the ”Morningstar analyst’s estimate of what the stock is worth.”

The Merrill projection of increased acquisition activity for XPO in 2018 was similar to that of Morningstar’s Young, which he made in December and reiterated in the latest report. He wrote that while none of Morningstar’s earnings projections on XPO assumed a deal, “management indicated the firm is back on the hunt for deals. We wouldn’t be surprised to see a transaction in 2018 as the firm continues to look for additional opportunities to expand its unique asset-light/asset-heavy operating model.”

Also in the Morningstar report is a declaration that XPO does not have an “economic moat,” another proprietary Morningstar term that it defines as “how likely a company is to keep competitors at bay for an extended period,” a designation that would not fit many companies in the ultra-competitive trucking sector. Still, Morningstar wrote: “By no means are we implying that investors should avoid investing in the shares under the right circumstances, and we wouldn’t hesitate recommending XPO at an adequate margin of safety to our fair value estimate.”

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