XPO Logistics' (XPO 1.22%) recovery from a disastrous second half of 2018 hit the fast lane in the second quarter, with the transportation specialist beating estimates and raising guidance. After a decade of growth fueled by acquisitions, XPO is making the case that it can generate solid results without M&A.
It's far too soon to predict whether XPO will get back to the high-flying ways that generated a 3,000% stock return over a 10-year period that ended last fall, but market confidence in XPO is returning. Here's a look at the latest results and what investors can expect down the road.
XPO 10-year chart data by YCharts.
XPO delivers a much-needed earnings beat
In early August, XPO reported adjusted earnings of $1.28 per share, easily surpassing the $1.04 per share estimate. The news wasn't all good. Revenue, similar to that for many transportation names this quarter, was down 2.8% year over year and missed expectations by $130 million. And it is worth noting that the company had previously reduced guidance. But investors took a glass-half-full view on the report, sending shares up more than 10% following the release.
The company is trying to get back on track after weathering a series of negative developments that cut its share price nearly in half. XPO's issues began late last year with a blistering criticism from short-seller Spruce Point Capital and were compounded with weaker-than-expected fourth-quarter results, including the unexpected loss of a major customer. XPO didn't identify the customer, but it is believed to be Amazon.com.
XPO trimmed its management ranks in March, raising questions about the historically acquisitive company's future M&A plans. And its first-quarter results did little to ease investor concerns.
Image source: XPO Logistics.
The latest results show signs the business is back to running as planned. Management raised the low end of full-year EBITDA guidance to $1.675 billion from $1.650 billion and said the company expects to generate at least $1 billion in EBITDA from its less-than-truckload (LTL) segment in 2021. Contract renewals in the highly competitive LTL unit have come in on average up 5.2%, up from 3.7% increases in the first quarter.
Free cash flow guidance was also raised to $575 million to $675 million, up from $525 million to $625 million, despite revenue that is expected to be flat compared to previous guidance for 3% to 5% growth.
Backfilling Amazon
The large customer that walked away from XPO, believed to be Amazon, was able to make a dent in results because it had grown to account for more than $500 million worth of annual sales. XPO CEO Brad Jacobs admitted in May that allowing one customer to be that large was "a mistake," and for 2019, XPO expects no customer to account for more than 2% of revenue and the top five customers combined to make up less than 10% of total sales.
Still, the departure left a big revenue hole to fill. Slowly but steadily, XPO is addressing it. Management said on a post-earnings call that the company's global sales pipeline grew to $4.4 billion, up 31% year over year and up from $3.5 billion in December. XPO won $1.04 billion in new business in the quarter, down 5% year over year but up 4% year to date. North America is leading the way, offsetting continued weakness in Europe, which has been mentioned by XPO and other transport giants.
"There's a cliché that says there's nothing like a hanging to concentrate the mind," Jacobs said on the call. "And when you lose $600 million of business like we did at the end of last year, you concentrate, you get focused, and that's what the organization did."
XPO also sees the opportunity to improve profits by $700 million to $1 billion annually by 2022 via cost cuts, including new workforce productivity tools, logistics automation, and process improvements, as well as using pricing analytics and revenue management tools.
The roadmap for growth
XPO under Jacobs has been a roll-up machine, and the company's hiatus from dealmaking, announced earlier this year, threatened the traditional bull case for the company and led to questions about where future growth will come from. On the call, Jacobs did not rule out a return to dealmaking, especially as transaction multiples have come down in recent months, but still sees good value in repurchasing XPO shares.
Absent M&A, XPO sees opportunities for organic growth in businesses like XPO Connect, a cloud-based digital freight marketplace for shippers, and XPO Direct, which aims to help retailers compete with Amazon by providing a suite of products including warehousing and last-mile delivery. XPO Connect has grown to 28,000 carriers, and the still-small managed transportation segment that houses it saw revenue grow nearly 25% in the quarter.
XPO Direct, meanwhile, is particularly intriguing. The service is XPO's primary weapon in trying to gain share in the e-commerce and omnichannel retail worlds. While few individual retailers have the size and scale to match Amazon and its investments in logistics, they can gain some of those efficiencies by banding together through XPO Direct. The unit is on track to reach a $1 billion revenue run rate by 2022.
Overall, this transportation company invests more than $500 million annually in technology and employs more than 1,800 tech professionals.
XPO is hitting the accelerator
It was easy for XPO investors to get caught up in the onslaught of negative headlines early in the year, but through it all, this remains a profitable and growing company. And unlike a few years ago, the argument can now be made that XPO shares are undervalued. The company trades at an enterprise value less than 8 times EBITDA, well below the multiples of United Parcel Service, FedEx, Old Dominion Freight Lines, or C.H. Robinson Worldwide.
Transport EV to EBITDA (TTM) data by YCharts.
One could argue that none of those companies is a perfect comparison to XPO, but all of them are facing the same competitive threats and macroeconomic headwinds.
It's still hard for me to believe XPO's next decade can be a repeat of the growth the company enjoyed in the previous 10 years without several well-executed acquisitions. But in XPO Direct and its other technology initiatives, the company is at least laying the foundation for outsized organic growth.
XPO's recovery is far from over, but it appears to be going to plan. Coming out of this quarterly release, investors should feel more comfortable about holding on through the troubles. And for those with the patience to wait out macro issues and XPO's work to revamp its business, it looks like a good time to buy in.
