Top XPO Logistics Inc. executives have been telling investors over the past few weeks that they don’t share concerns that an economic “hurricane” is about to hit the U.S., saying they haven’t seen a dramatic decline in demand for the company’s services.
The XPO (NYSE: XPO) C-suite, led by Chairman and CEO Brad Jacobs, has made the rounds of investor meetings through May and June to discuss macro conditions, industry trends and the company’s competitive position in its two main businesses: LTL and truck brokerage. XPO synthesized the questions and answers from the meetings into a 19-page report that was released earlier this month. None of the questioners or respondents were identified, though in one or two instances it is clear that Jacobs is the executive who is answering.
In one of the sessions, an XPO executive was asked why after spending four years acquiring and integrating 18 companies, it is selling or spinning off everything except its North American LTL business. The executive responded that XPO had “created a stock that relatively few investors were interested in” because it was a complex creature with many moving parts.
“We were a really great company [but] with a low multiple, because the stock market wasn’t in love with us,” the executive said.
To earn Wall Street’s love, XPO began to shed virtually all of its assets, starting with its contract logistics business, now known as GXO Logistics Inc., (NYSE: GXO) which was spun off last summer. The company sold its intermodal business in March and has put its freight forwarding business up for sale. It will spin off its brokerage, final-mile and managed transportation operations by the end of 2022. It also plans at some point to sell or publicly list its European business.
It hasn’t helped much up to now. XPO shares, which traded at near $91 a share in mid-August, closed Wednesday at $45.70. Analysts, for their part, remain upbeat on the shares, with 12-month price targets in some cases of well over $100 a share. XPO estimates that its shares are trading at a low valuation of less than seven times earnings before interest, taxes, depreciation and amortization, the bottom-line metric favored by Jacobs.
One challenge for XPO is convincing investors it can reduce its net debt — or leverage — to levels of around one times EBITDA. XPO has reduced its leverage ratio to two times EBITDA from 2.7 times EBITDA last year. Still, the current ratio remains too high to attract a wide swath of institutional money, an executive said.
“We have a list of hundreds of institutions that own [shares of] our competition or similar companies but don’t own us,” the executive said. Of those, more than half won’t buy XPO shares because of its current debt position, the executive said.
“We think there are roughly 500 institutions that could open up once we [bring] the leverage down,” the executive said.
Next LTL phase
XPO executives said they are about to embark on the “next phase” of the company’s LTL strategy, which is to dramatically grow the unit’s revenue while maintaining healthy margins. XPO has focused on cost-cutting-driven margin expansion since it entered the LTL business in 2015 by acquiring Con-way Inc. for $3 billion. To an extent, however, the company sacrificed top-line growth by not investing heavily in the business.
“We went into LTL with the plan to put 3% to 4% of revenue” into capital spending and still achieve a robust multiple, one executive said. What XPO discovered was that some competitors put as much as 15% of their revenue into capex, and came away with twice the valuation multiples, the executive said.
“The market wants to see growth, not just margin expansion,” the executive said. “We’re going to invest in the fleet and network. We’re going to substantially increase our capex, and we’re going to grow the top line in addition to growing margin.”
Part of that investment will be directed at building more truck trailers in-house and adding more drivers, steps that XPO believes will reduce its overreliance on expensive third-party transportation known as “purchased transportation.” Until the pandemic, about 25% of XPO’s line-haul miles were operated by third-party providers, down from 35% in 2015. “The goal is to bring that percentage down to closer to 5% over time,” an executive said.
XPO spent $136 million on purchased LTL transportation in the first quarter, up 44% from the 2021 quarter. Supply chain problems, notably with a continued dearth of microchips embedded in vehicles, are constraining in-house capacity utilization, an executive said. “We could take three times as many tractors as we’re currently getting” from truck manufacturers, one of the executives said.
Despite the many investments it will make that will drive up costs, XPO is on track to bring its operating ratio — the ratio of revenues to expenses — below 80% at some point. “The investments don’t dilute a path to that,” said one of the executives. Adjusted operating ratio, which began the year in the high 80% range, is expected to settle at a full-year average of 83.3%.
Brokerage in high cotton
XPO’s truck brokerage business, which has posted blowout quarters for the past 18 months, is in a different situation. The company is leveraging massive upfront investments in brokerage technology to source or cover about three-quarters of its loads digitally, one of the executives said. That level should rise to 95% in a few years, according to the executives. Improved efficiencies, and a strong tailwind in the spot or noncontract market, have made brokerage a high-margin business for XPO.
The company expects additional margin improvements even as spot and contract rates decline, an executive said. Most customers want 12-month brokerage contracts so they can be insulated from sudden cost increases, the executive said.
“Shippers don’t want to be burned again by costs going up and up,” the executive said. “Even though the spot market is softer now, they don’t know when it’s going to be firm. China’s opening up. Maybe three months from now, there could be a tight market again.”
XPO executives said that the company’s customers in general are not increasing their inventory levels in response to potential supply chain disruptions, but that they want the right levels of the right products in the proper locations. “They’re not going back to the time” of having two huge bicoastal distribution centers and a third in the Midwest, an executive said. Instead, they’re moving toward “right-sized” distribution centers positioned closer to the end customer.
Consumers are unlikely to unlearn their “want-it-now” behavior, the executive said. As a result, supply chains will become shorter and faster, and be supported by more fulfillment and distribution centers than in the past.
The pandemic-related factory lockdowns in China, and the specter of them soon opening up, is uppermost in LTL customers’ minds, according to an XPO executive. North American industrial customers, an LTL carrier’s bread and butter, have been “choked by the lack of goods coming out of China,” the executive said, adding that it was “surprising” to see how “pervasive” this issue is with XPO’s customers.
(An earlier version of this story mistakenly said that the spin-off of the brokerage business would occur by the end of 2021).