XPO Logistics (XPO) has had quite a dramatic fall over the last few months. The stock price went down by more than 60% before recovering somewhat. This is the evolution of the stock price since October 1, 2018, somewhat four months ago:
(XPO truck, source)
In this article, I want to examine if XPO could bring truckloads of alpha to your portfolio by returning to its all-time highs or not. Was the big drop in the stock price justifiable? Should you buy now?
XPO, the company
XPO is a transportation and logistics company. These are the different solutions they can offer their clients:
(Source: XPO website)
XPO Logistics operates in 31 countries, has more than 90,000 employees and 1,435 locations. Of those 90,000 employees, there are 1,600 IT workers and the company invests more than $425M annually in technology. In that way, it can find the best solutions for the customers and for itself. Currently, the company has more than 50,000 customers. To show the huge size on which it works: it handles 160,000 shipments and over five billion inventory units every day. Since XPO bought 3PD in 2013, the company is the largest provider of last-mile logistics for heavy goods in North America.
For the bicycle race lovers a special detail: XPO has handled the logistics for the Tour de France race for 38 years. It transports 360 tons of official equipment over 270,000 kilometers during the event, including podiums, barriers and gates, furniture, audiovisual equipment, sponsor merchandise, and marking paint. (Source: Wikipedia)
Here are some interesting financial numbers:
One of the first things I always look at for stocks is the market cap. I like companies that are not huge giants yet, but have plenty of room for growth. It's easier to grow from $1B to $10B than from $50B to $500B. That is the law of large numbers. But this doesn't exclude $50B market cap stocks. XPO has a market cap of $7.3B, which gives it room for growth.
XPO: the stock price
XPO's stock price at the time of writing is $58.62. The typical growth stock trail has been followed: the stock has been very volatile over the last years:
As you can see, the stock has fallen dramatically over the last four months. XPO fell more than 60% in less than three months.
If you look at the longer term, there is no competition:
XPO's big drop: the reasons
As it often goes with a stock drop like this, there is a combination of several factors, a perfect storm:
- A big Q3 earnings miss on October 31, 2018: Non-GAAP EPS missed by $0.09 at $0.89 but GAAP EPS came in at $0.74, a miss by $0.21 from consensus. But the revenue grew 11.5% YoY, led by contract logistics and freight brokerage and XPO was able to close $918 million of new business in Q3 2018, up 43% YoY. So on itself, this isn't too bad.
- In the same announcement on the same day, XPO cuts its FY 2018 EBITDA target to $1.58B from $1.6B. The reason: a bankruptcy of one of its clients in the UK. But at the same time, XPO reaffirms its 2017-18 target of $1B of free cash flow. On its own, this doesn't seem to be so bad, but together with the earnings miss, it hammers the stock down.
- There was also bad publicity around the conditions in XPO's workplace. Senators asked questions about this and of course, that is always bad for the reputation of a publically traded company.
- On December 12, with the stock already down 47% of its 52-week high, the company announces that it cuts its earnings forecast for 2019. Instead of 15% to 18% growth, XPO now expects 12% to 15% EBITDA growth for 2019 and $650M in free cash flow in 2019, up only 4% from its outlook for $625M in 2018. The reason is probably tax payments after previous losses have been exhausted for tax credits. The stock falls more than 10% again, bringing it down 60% from its highs.
- Spruce Point Capital calls XPO an excellent short and says it could go to zero.
- In mid-January 2019, there was a downgrade to sector perform by KeyBank, which caused XPO's stock to fall again.
The interesting point for me is that Spruce Point compares XPO to United Rentals (URI), another company of XPO CEO Brad Jacobs (which I will come back to). United Rentals had to pay $14M of settlement for fraud charges in 2008 (when Jacobs had already left). The stock went down to $3 and change, but it is at $126 now (and has a 52-week high of $190). I think that, as usual with shorters, the allegations are exaggerated a lot, but short reports like these sometimes can point at irregularities. If this is the case for XPO, I think it will indeed be more like URI: smaller accounting mistakes. But at this moment, these are just allegations from a shorter, not nearly as bad as United Rentals' case yet.
The big drop has made that XPO is undervalued right now, according to Simplywall.st based on future cash flow:
FAST Graphs also shows that historically XPO is undervalued, both versus its average P/E ratio (the blue line) as versus its earnings growth rate (the orange line):
So this could be a good moment to buy XPO shares, which doesn't mean, of course, that cheap couldn't get cheaper.
Transportation: the new paradigm
The main reason I like XPO is because of the growth in e-retail since XPO has the largest outsourced e-fulfillment platform in Europe. A lot of us, me included, buy more and more online. Amazon (AMZN) has become a giant force in retail because of this evolution, but others follow. Walmart's (NYSE:WMT) online sales for example also grew by 43% in the last reported quarter.
As customers we expect our purchase to be brought to our door as soon as possible. While Amazon works with its own logistics, UPS (UPS), FedEx (FDX) and many others, XPO is an important partner for the transport of larger goods, such as fridges and dryers.
But there is a lot more. Where online grocery retail is still in its infancy stage, this is expected to be booming over the next decade. It could grow by 500% or more over this period and by 2025, we could be doing 25% of our groceries online. XPO has the experience here too, with for example Koninklijke Ahold Delhaize (OTCQX:ADRNY) as one of its clients, the sixth biggest grocery retailer in the world.
Brad Jacobs on the Q3 2018 earnings:
Looking at our lines of business, contract logistics was the standout once again. We grew our logistics revenue year over year by 13%, with e-fulfillment ramping up globally.
But the transportation sector is fragmented and there is more and more specialization. What makes XPO stand apart from a lot of competitors is that it uses a business model which needs somewhat fewer assets. It is actually also a kind of middleman between shippers and carriers. Truckers, owners of container ships, barges etc. can bid to get the contract and in that way, XPO can make sure they get the best price for the best transport solution for their client. Brad Jacobs about this on the Q3 2018 earnings:
Freight brokerage was another highlight. We grew our North American brokerage revenue by 18%, and notably, we increased brokerage net revenue by 46%. We launched XPO Connect from scratch in April. Three months later, 6,000 of our carriers had opted in, and in the three months since then, we’ve expanded to over 13,000 carriers. We expect the count to keep climbing fast; these are quality operators in our core network.
XPO's CEO: an asset
One of the most valuable aspects of companies is having a visionary CEO, a great leader that has exceptional qualities and a bird's view of where the company should be heading.
In the case of XPO, I have great confidence in its CEO and chairman Brad Jacobs. Jacobs is a leader with quite a few miles on his business meter.
(Brad Jacobs, XPO's experienced CEO, source)
Brad Jacobs is 62 years old now, but the man has more experience than a lot of others who are quite a lot older.
Besides the chairman and CEO of XPO, Jacobs is the director of his own private equity partnership Jacobs Private Equity, LLC. He is number 302 in the Forbes 400, the list of the richest people in the US, with a current worth of $1.7B. That used to be more, but since Jacobs owns quite a lot of XPO stock, his worth has come down quite a bit.
At the age of 20, Jacobs dropped out of school to be able to be a full-time oil contracts broker. Three years later, at the age of just 23, he founded and was the CEO of Amerex Oil Associates, an oil brokerage company. In 1983, the firm was sold. Today Amerex is a part of BGC Partners (BGCP).
In 1984, a year after he had sold Amerex, Jacobs founded Hamilton Resources also an oil trading company, but this time in the UK. Again he was the chairman and CEO and was able to grow the company to a big player.
In 1988 he returned to the US, where he founded yet another company, United Waste Systems. This time he acted outside of the oil industry: he wanted to unite garbage collectors in rural areas. In 1992 the company made its IPO on the Nasdaq. In 1997 United Waste Systems was sold to Waste Management (WM) for $2.5B. In those 9 years, Jacobs had done more than 200 acquisitions, which adds up to one every 16 days. That may have been a world record at the time, I don't know, but in any case it is an enormous number of takeovers. I think you can guess by now that Jacobs is seen as the king of acquisitions.
Just a month after he had sold United Waste Systems, Jacobs formed United Rentals and again served as the chairman and CEO. After two months already, in December 1997, the company made its IPO on the NYSE. It grew enormously and just ten years after the founding, when Jacobs left, the company was the 536th largest public company in the USA. And how do you think Jacobs pulled that trick? Indeed, acquisitions again. He even had more than in his United Waste System days: more than 250 in ten years, or one every 14 days.
In 2011 Jacobs finally became the chairman and CEO of XPO. For $150M he bought 71% of Express-1 Expedited Solutions and changed its name to its ticker symbol: XPO. After five months at the helm of the company, Jacobs announced that the company would grow its revenue from $175M annually to $5B within five years, which meant 2017, using his favorite toy: acquisitions. Just to show you that Jacobs is not a bluffer: XPO's revenue now is $17B.
Jacobs' goal is always to acquire and scale. In that way, he can cut expenses and increase profitability. I think Jacobs is one of a kind and a big advantage for XPO. And he has brought key people from his team along with him.
In December 2018, after the fall of the stock, the company announced a share buyback program of $1B. That is quite a lot if you know that the company has a market cap of just $7.3B at the moment of writing and hopes to have $1B of free cash flow over 2017 and 2018 combined.
The company is releasing its earnings of Q4 and FY 2018 on Thursday, 14th, Valentine's Day, after the market has closed. One of the things I will be looking at, besides the earnings themselves, of course, is how many shares have already been repurchased at these low levels. I will also pay attention to the debt level too. How much debt has been added to fuel the share buyback?
I am also very curious about how the earnings will be, of course. Will Brad Jacobs be able to say again, as in the Q3 2018 earnings:
We again grew our profitability faster than revenue.
Logistics is a cut-throat business. XPO tries to tackle that by using robotics and technology. I want to know what the plans are there. I hope an analyst will ask about these plans.
A metric that I will have a close look at is FCF (free cash flow). This is the lifeblood of any company. It is from the FCF that the money for buybacks and acquisitions should come. XPO said that it expected more than $400M of FCF in the fourth quarter. I'm not sure if they will hit that target. But if they do, it will be a very positive sign. Another target was to hit $1B of FCF over 2017 and 2018. Tomorrow evening we will know if this target is in the pocket.
This is the history of XPO's FCF:
As you see, there is a reverse correlation between the FCF and the debt-to-equity. At the end of 2015, this D/E was high because of the acquisitions made in that year. Since then XPO has drastically deleveraged. I wouldn't be surprised if the levels of debt would go up again over the next year, either for the buybacks or acquisitions and probably both. The company also has cash on the balance sheet: $428M to fuel buybacks and acquisitions.
I think XPO is a great company and Brad Jacobs is one of the greatest growth leaders in America and probably the world. His strategy has worked out well in the past and I don't see any reason why it wouldn't continue to do so in the future. A lot of negativity and headwinds are already baked into the price of XPO now. With the e-commerce market expected to keep growing exponentially for years to come, I think XPO will thrive over the long term. Especially the booming trend of fresh foods distribution via e-commerce is in its advantage.
XPO's free cash flow is robust and will fuel buybacks and acquisitions. There are some elements to keep in mind, though:
1. A general recession could harm the whole recession-sensitive sector and so XPO too.
2. The accounting scandal Spruce Point Capital refers to should be monitored, even though I think this will be either a non-subject or have only a minor impact on the business. It could hurt the stock, though.
3. The debt load could go up again over the next few years, but normally Jacobs is one of the best to deal with that.
Brad Jacobs is, in my opinion, one of the best CEOs around. He has brought XPO from a small company to one of the biggest transportation moguls in the world. Once XPO goes on an acquisition hunt again, I'm pretty sure it will be accretive for the company and its growth.
I have bought the first batch of shares and I might accumulate more since I think this is one of the best companies in transportation, even though it has its risks. But at a forward P/E of 14.12 (according to finviz.com) and high growth expectations, this could bring truckloads of alpha to your portfolio.
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In the meantime, keep growing!
Disclosure: I am/we are long AMZN, XPO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.