When transportation broker XPO Logistics (NYSE:XPO) shelled out $3 billion to buy trucking firm Con-Way last year, investors were anything but thrilled with the deal. News that XPO then turned around last week and sold off much of Con-Way's North American business to TransForce, and for only $558 million, didn't exactly improve their opinion of the 2015 deal -- except for one investor in particular.
This morning, analysts at Germany's Deutsche Bank announced that unlike the investors who sold off XPO stock last week, it's actually pretty enthusiastic about the "massive transformation" that XPO is engineering these days. In fact, the sale of XPO's truckload-weight business to TransForce appears to be a key factor in Deutsche's decision to upgrade XPO shares to buy and assign the stock a $60 price target.
Here are three things you need to know about that.
1. A "solid positive"
As reported on TheFly.com this morning, Deutsche is characterizing XPO Logistics' deal to sell off its truckload weight business as "harvesting" profits from last year's purchase of Con-Way. That may sound counterintuitive, given that XPO is getting a lot less money for some of Con-Way's assets than it originally paid to acquire the whole company. But Deutsche isn't alone in its view.
Citigroup also chimed in this morning, arguing that this new sale is a "solid positive" for XPO, and will increase the firm's ability to generate free cash flow, reduce its debt burden, and increase the value of the company as a whole.
2. Increase it how much?
By Deutsche's estimation, unloading Con-Way's TL business creates a chance for as much as "80% upside in shares of XPO Logistics." That's according to a write-up on the upgrade from StreetInsider.com, which goes on to quote Deutsche predicting XPO will grow its earnings before interest, taxes, depreciation, and amortization by 30% over the next two years, and increase its annual cash flow by $300 million.
Additionally, XPO itself says it will use the $558 million generated from its TransForce sale to pay down some of its own debt -- which has grown to $5.5 billion since the Con-Way acquisition last year.
3. A reversal in fortune
So what does this mean for XPO, in dollars and cents? Well, on the balance sheet, it implies a debt load shrinking below $5 billion, and considering the company's cash balance, a net debt balance of only $4.5 billion. That's still a heaping load of debt on a stock whose market capitalization sits below $3.6 billion today, but at least it's an improvement.
Improvements on the company's cash flow statement could prove even more dramatic. Unprofitable today, and with free cash flow running at negative $50 million, XPO isn't currently generating the kind of cash it needs to make meaningful progress in paying down its debt load. If Deutsche is right about XPO's ability to grow its cash flow by $300 million annually, however, then this sale of Con-Way's truckload business to TransForce could free up enough cash to turn XPO into a free-cash-flow-positive business -- the first time that's happened in five years. (According to data from S&P Global Market Intelligence, XPO last generated positive free cash flow in 2011 -- and only $5.8 million even then.)
The most important thing: Valuation
But is all of this enough to transform XPO Logistics stock into the buy that Deutsche says it is? That's where I'm less certain.
Assume, for a moment, that Deutsche is right about the cash flow boost that XPO Logistics will receive from this deal. Assume that in two years' time, XPO will indeed be generating positive cash profits of $250 million or thereabouts (today's negative $50 million, plus Deutsche's promised $300 million). Assume, too, that net debt drops to $4.5 billion, and XPO's market capitalization stands pat at $3.5 billion.
All this would leave us looking at an XPO Logistics stock with $7 billion in enterprise value, generating free cash flow of $250 million, and therefore valued at an enterprise-value-to-free-cash-flow ratio of 28. That still sounds pretty high, but S&P Global figures show that most analysts who follow the stock anticipate 35% annual earnings growth at XPO over the next five years. If they're right about that, then 28 times free cash flow could actually be a bargain price to pay for XPO Logistics stock.
Long story short, you have to make a lot of assumptions to come up with the conclusion that Deutsche Bank ends up with -- that XPO Logistics is a buy. But assuming those assumptions play out as promised, the analyst appears to be right: A buy XPO is.
Fool contributor Rich Smith does not own shares of, nor is he short, any company named above. You can find him on Motley Fool CAPS, publicly pontificating under the handle TMFDitty, where he currently ranks No. 333 out of more than 75,000 rated members.
The Motley Fool recommends XPO Logistics. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.