The fourth-quarter results posted yesterday by XPO Logistics, Inc. (NYSE:XPO) reveal as much about Amazon.com, Inc.’s logistics intentions as they do about XPO’s outlook.
XPO’s “largest customer,” which the company won’t identify but which everyone believes to be Amazon (NASDAQ:AMZN), is taking away $600 million of annual spend with XPO and bringing it in-house. That amounts to two-thirds of the customer’s total spend with XPO. The first tranche, which disappeared last quarter, was so-called postal injection, where XPO moves goods from fulfillment centers to local post offices for deliveries to residences. The move happened suddenly and near the end of peak season. XPO knew the business would eventually depart, but it didn’t know when. Yet it had to allocate assets as if it was business as usual.
The inability to quickly replace such a large amount of business blew a huge hole in the company’s last-mile results. As a result, XPO reported that its key earnings metric – EBITDA – fell short in the fourth quarter, and that quarterly operating income in its transportation and logistics divisions declined year-over-year. In the case of transportation, the year-over-year drop was a substantial $25 million.
The company also lowered its guidance on 2019 results, saying revenue would grow 3 to 5 percent, EBITDA would rise by 6 to 10 percent, and free cash flow (FCF) would fall between $525 million and $625 million, down from the $650 million previously forecast. The FCF decline is due to a $275 million interest expense on $1 billion in debt that will be used to repurchase up to $1.5 billion in shares, which the company believes is quite undervalued at current levels.
For XPO, the hit from the customer defection will linger well into 2019. The business that didn’t go away last quarter will mostly depart in the first half. The “postal injection” segment that was the subject of XPO’s fourth quarter angst will account for $200 million of lost revenue, Brad Jacobs, XPO’s chairman and CEO, (pictured above) told analysts today. The other $400 million will come out of brokerage, intermodal and contract logistics, Jacobs said. The $300 million that’s left is locked up in three-year contracts, though Jacobs said he was unsure if all of that would remain intact.
If the customer is indeed Seattle-based Amazon, it is another example of the company wanting to capture as much volume within its in-house network as is feasible. It also highlights the risk to shipping partners, even those with long-standing relationships with Amazon, if the e-tailer feels confident it can gain control of its traffic and do it more cost-effectively than its vendors. The consensus is that Amazon’s volumes are so vast and growing so rapidly that it will be impossible for it to consistently hit delivery commitments without outside help. The consensus has been known to be wrong, however.
Amazon, as it often tends to do, has sent mixed signals. On its fourth-quarter analyst call, executives said the company values its delivery partners. Yet in a recent Securities and Exchange Commission filing, it referred to some of those same partners as competitors.
If today’s equity market moves are any indication, investors and traders believe that Amazon is indeed the XPO customer, and that its move has broader implications beyond XPO. Unsurprisingly, XPO shares traded sharply lower because of the company’s disappointing results (though the stock closed off its worst levels). Yet shares of FedEx Corp. (NYSE:FDX) and UPS, Inc., (NYSE:UPS) both of which haul for Amazon and on the surface should not be severely affected by company-specific news involving another provider, were also down. The much-sharper sell-off in FedEx shares may have also been prompted by the unexpected news that its president and COO, David J. Bronczek, would retire at the end of the month, and also retire from his seat on FedEx’s board.
For their part, XPO executives tried to put the best face on the fourth quarter actions of their “largest customer.” The fulfillment center-to-post office segment has low barriers to entry and exhibits little value-added differentiation, they said. By contrast, the “over-the-threshold” delivery of heavy goods, a business that XPO dominates and which involves delivery, installation and take-away, is high-margin and value-added, they said. Jacobs, for his part, said the company expects to replace the lost business during the second half of the year as more volume from the 118 new contract logistics accounts signed up last year come on-stream.
Still, Jacobs was forced to do today what he has done little of in XPO’s mostly-charmed seven-year life – publicly admit problems and mistakes. “It hurts,” he said when describing the impact of the lost business. The Greenwich, Connecticut-based company, which has dazzled analysts and investors with its business model and the rapid growth supporting it, now faces hard questions from the same people who have been in its corner and are now starting to doubt its story. Noting that XPO fell short of expectations for the second straight quarter – third-quarter results were revised down after the bankruptcy of U.K. retailer House of Fraser, a large XPO logistics customer.
Jacobs acknowledged that “we’ve slipped on (the) banana peel twice.” Analyst skepticism about the company’s recent performance is “understandable,” he said, adding that missing projections and lowering guidance after such a stellar multi-year run is “not our track record and it’s not who we are.”
XPO has been guiding down expectations for some time, due in large part to weakness in two key European markets – the United Kingdom and France. Uncertainty over Britain’s scheduled end-of-March exit from the European Union (EU) has curbed business. Meanwhile, the ongoing protests in France over proposed budget cuts by President Emmanuel Macron have turned sentiment upside down compared with a gung-ho outlook during 2017, Jacobs said. A “hard” Brexit, meaning the country would leave the EU with a clean break, would be very negative for the British economy and, by extension, XPO, Jacobs said. The situation in France isn’t likely to change, so sentiment there will remain muted, he added.
Analysts, by and large, seem willing to give XPO the benefit of the doubt. But their patience is wearing thin. Perhaps the most telling reaction came from Amit Mehrotra, Deutsche Bank’s lead transport analyst. Mehrotra has been one of XPO’s staunchest bulls, going so far as to write a near point-by-point rebuttal in mid-December to a short-selling firm’s scathing report on XPO that sent the equity plunging more than $15 a share in one day. In a note published this morning that started “not as bad as it looks (even though it looks really bad),” Mehrotra said he doesn’t think “the fundamental story has changed.” Revenue and cash flow prospects still look promising despite the loss of the customer, Mehrotra said. He added, however, that yesterday’s results put XPO “deeper into the penalty box.”