It's a grab bag of topics on this week's episode of Industry Focus: Energy, as host Nick Sciple is joined by Motley Fool contributor Lou Whiteman to break down the good and bad news that's coming out of SpaceX, the latest plane troubles at Boeing (BA +1.97%), UPS (UPS 1.04%) earnings, and more. Listen to the end to hear about Lou and Nick's favorite shipping/logistics stock: XPO Logistics (XPO +2.29%).
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This video was recorded on February 4, 2021.
Nick Sciple: Welcome to Industry Focus, I'm Nick Sciple. We've got a big show for you this week. SpaceX has all kinds of news. Boeing has more plane trouble, and UPS just reported earnings buoyed by the surge in online shopping we've seen during the pandemic. Joining me to help break it all down is Motley Fool contributor, Lou Whiteman. Lou, thanks for joining me.
Lou Whiteman: Always a pleasure.
Sciple: [laughs] As I said off the top of the show, a very Fool show, lots of topics going on this week. I just want to get into it right off the bat. First off, we've got SpaceX in the news this week for lots of reasons, some of them good, some of them bad. I want to go with the good news first. SpaceX says they're going to send their first all civilian crew to Orbit this year.
Whiteman: The funny thing about this is how quickly this suddenly looks routine. I mean, it was less than a year ago, it was May 2020 that we were celebrating the crew Dragon doing its first launch to the space station. It almost feels routine. There is going to be one of those Dragon capsules parked at the space station almost indefinitely from now on. It's a next step from there, but it's really amazing to see how much this story has shifted in a very short amount of time from concept to actual, no, we're doing this, it's the one.
Sciple: Lou, hot-seat, Virgin Galactic, what do you think?
Whiteman: The real question is, how much demand is there at these price points? I would much rather be SpaceX with a diversified business right now than Virgin Galactic. They're planning other things, but right now, they are so reliant on this. I certainly think that they'd be watching this carefully and would be nervous about it. Sure.
Sciple: It is interesting, we go from nobody has ever done this before to now, there's competition, as you said. We'll see what happens. I mentioned there were some good news and bad news. On the bad news side, on February 2nd, we had another test failure for SpaceX. What's going on there?
Whiteman: Right. It's important to note that this is a separate program than the one that is putting people in the space. This is the starship. This is Elon Musk's grand dream. This is what's going to take us to Mars. It's a very big, complicated new spaceship, they are testing it right now. Just this week, they did a test. It hit its target, it went about 10 kilometers in space which is maybe one-tenth of what you need to get into space, but they had a fireball crash upon landing. It's very similar to December, [laughs] the last version of this also crashed in December. Very similar, it went up. They claim they get a lot of data from this. The issue is still on the landing. This was Musk's thing to reuse these things and to figure out how. That's where they're having trouble. There are a lot of positives, but it also points to the fact that this is early stages for that.
Sciple: Right. I think I asked you about it last time when we talked about the previous incident, we talked about how these flights are becoming more routine. These types of accidents, are these something we should just expect in the rocket business?
Whiteman: Definitely at this level, because again, this is a craft that is far from bringing people or even payloads into space. This is a crash of Beta software. If you think about it [laughs] to use that analogy. If this was the Falcon 9 or some of their more just in-use, then it would be more of a worry. This is bleeding-edge and bleeding-edge sometimes fails spectacularly.
Sciple: Move faster and break things, I guess. [laughs] It's still in the testing stage. We're in the testing stage.
Whiteman: They need to take a deep breath.
Sciple: We want to do that in the testing stage.
Whiteman: Right.
Sciple: One other thing is a couple of potential issues from a federal perspective, both from a hiring and a permitting point-of-view. Thoughts on that, SpaceX is a government contractor so that is a significant business for them.
Whiteman: Both of these are just interesting side notes, but maybe it's something more if you put them all together. The DOJ is investigating a complaint claiming SpaceX discriminated against the non-U.S. citizen for hiring. It's not really clear what happened. As you say, this is a contractor, it could even be something caught up in that in a bigger issue than we know, but that's one investigation. There's also this flight that crashed this week was delayed because the FAA temporarily suspended their license for "violating the terms of their public safety agreement." SpaceX didn't comment but Musk went on Twitter and complained the FAA is fundamentally broken and will prevent humanity from going to Mars, all this stuff. Again, whatever it was, it was worked out, they were allowed a few days later to do the test. If there is a takeaway here, we've seen this with Tesla too, Musk has a very cavalier attitude toward regulators, the SEC, whoever it is. That's great when it works but just be careful because we are talking about whether it's autopilot, people on the roads, or eventually, some of these. The FAA sounds like it was concerned that people living in the vicinity could have been affected by the test. There is a need with these things [laughs] to show some caution and a cavalier will allow you to do great things, it can also get you in a lot of trouble. So just be careful.
Sciple: This can be a complicated thing in this industry. We'll see what happens. Very exciting things going on at SpaceX. Nonetheless, we talk about maybe [laughs] some spats with the government and some bad news surrounding a business, I think that has described Boeing over the past couple of years [laughs] for sure. What's going on with Boeing lately?
Whiteman: The good news is we're not going to talk about problems with the 737 MAX. The bad news is we're going to talk about problems with the 777X which is a new version of their largest plane, this is their across the ocean international plane. It was delayed even prior to the 737 MAX. It was supposed to be flying by now. But now, post 737 MAX, with all the issues that were uncovered, the regulatory scrutiny to get this thing certified is going to be all the more intense. Now, Boeing, just in the last few weeks, have said it's not going to be 2022 when it's flying as they hoped, they're hoping for late 2023 which is just light years for this industry. More to the point, this is turning into a real albatross of a program, this is not the plane that airlines need right now. It is the biggest thing Boeing offers, it's focused on international flights at a time where we're not seeing international flights, and this is a huge, huge deal for Boeing that they've invested billions and billions in, and suddenly, there's real concern about when it's coming out and how it will stall.
Sciple: Give me some good news for Boeing. Because it seems like just over the past couple of years, there's just not a lot, there's just more bad news every day, it seems like. What's the positive spin? What's the light at the end of the tunnel for this company?
Whiteman: I'm going to answer this actually by doubling down with the bad news. [laughs] One of the things that we really have to watch with the 777X right now is that Boeing, in its annual report, reduced its order book by about one-third. Now, that's mostly an accounting thing. That's because it's going to be so late, some of its customers can back out of these deals and so they cannot count it as a firm deal anymore. It doesn't mean they will back out. Chances are they will see some cancellations. The good news here is that it might just save the Dreamliner program, which Boeing has also had to cut back on. The Dreamliner is a smaller version of this. It's still made for international flying but it doesn't have all of the seats, it's a little easier to operate in this environment, probably in the environment we're going to see. The Dreamliner is arguably a more important program for Boeing, and while they do not want to see the 777X end up as just a disaster, they would rather salvage the Dreamliner. We have the Dreamliner, hopefully, on the rebound, the 737 MAX is flying, airlines on their fourth-quarter call, they talked about passengers aren't pushing back. We're going to see cash burn, hopefully, slow if not go positive in 2021 with the MAX. The worst is over but it's really hard [laughs] to say, there's not a lot to throw a party about right now.
Sciple: I can hear a lot of folks saying, "Well, airline travel is going to come back with the vaccine and maybe that's going to snapback demand for aircraft," but with the nature of this business, there's a lag in how that plays out.
Whiteman: Especially in this situation when the airlines had to take on so much debt for them to just survive. Yes, I think there's going to be a rebound, but that rebound is largely going to be on the backs of existing metal and maybe there's a lot of planes you can get on the cheap right now. I think it's hard to make the case. We will see new plane sales because a lot of these contracts, you can't wave a lot of. I think it's hard to make the case that we will see new plane sales for either Boeing or Airbus accelerating within the next even five-year period, just as the airlines lick their wounds and try to get back to normal.
Sciple: Aftermarket part manufacturers might be an interesting area there?
Whiteman: Yes.
Sciple: Along the lines of we've seen this decline in travel, certainly, Boeing and some of these airlines that have been losers here, but for losers. There have been some winners. You mentioned earlier, UPS just reported earnings, e-commerce demand through the roof due to lockdowns and that people not wanting to be out of their home. What are we seeing from UPS out of their earnings report?
Whiteman: I think anyone who has a recycle bin probably [laughs] knows exactly what's going on with UPS. The number of Amazon packages and other cardboard you have out there. Sure enough, UPS had a great fourth-quarter report. They beat $266 per share on earnings from $24.9 billion of revenue. That was higher than consensus and consensus had been ratcheted up based on what FedEx and some of the others have said. The pandemic ended up being a good and a bad. We have seen B2C volumes soar, B2B lag, but the net-net is that the overwhelming surge in B2C offset a lot of the weakness they had in other parts of their business. Domestic package division saw a 17.4% increase year-over-year in revenue, it was the highest quarterly operating profit in company history. This is the right business for the time, this home delivery business, and it is really performing and we've seen that across the line with these logistics companies.
Sciple: It's just underlying. When you say B2C business versus B2B business, what are the distinctions there?
Whiteman: B2C, business to consumer, this is taking the package to your house to my house. B2B, it doesn't have to be two businesses, it could just be running transport from warehouse to warehouse for a customer, but it is business shipping that does not end up in the last mile to the house. It's the simple way to think of it.
Sciple: Traditionally, UPS has been focused on this business-to-business shipping. Seeing this big shift toward business-to-consumer with the rise of e-commerce, changes in patterns of how businesses are working, how does this setup for UPS as a business? Obviously, being that its legacy business was around it's business-to-business shipping, those advantages are as applicable in this business-to-consumer world?
Whiteman: In the ideal environment, the business-to-business tends to be a lot more profitable. There's a lot less cost. The last mile cost us substantial. That does tend to drag down margins on the business-to-consumer. The interesting thing is that UPS isn't really caught in the post office model where you have to go to every house, but largely these days the last mile is to every house. The advantage in B2B, and the interesting part of it is you can be more selective, you can play in the areas you want. For UPS that has been whether it's refrigerated, where it's time sensitive, areas like that where you can pick your battles and try to find a margin. That is a part of the business. Yes, they've done B2B forever, but most of their growth over the last decade or so has been to build out this business-to-business in the areas they want. One of the big questions for this company in 2021 is, how will this normalize? What will it mean for margins, or are we stuck in this rut for a while, because they very much want to see that B2B come back. They want that side of their business to outperform.
Sciple: Yeah. Price discrimination seems to be the magic core there. In the B2B, you can price discriminate in a way that you cannot on the business-to-consumer side.
Whiteman: Right.
Sciple: One other thing we see with UPS, and it's really a conversation across the board in logistics, is the role of Amazon. We've certainly seen FedEx cut loose from doing business with Amazon a while back, how should we be thinking about that relationship and it's importance for UPS?
Whiteman: Amazon has had some very high profile blow ups with a couple of different logistics companies, and UPS is the beneficiary. Amazon represented 13% of UPS revenue in 2020. It was already high in 2019, it was about 11%, but it is a growing number. That is both something to be excited about, and something to be nervous about because we have seen dust ups with other shippers. UPS is the preferred partner right now, it's a big part of their business. It can continue to grow despite everything Amazon is doing, but I see it almost as much as a risk as it is an opportunity. If I'm UPS, I'm not trying to dump that business, but I'm not counting on that growing, just because Amazon is constantly doing new things. I think it's just something to watch with them.
Sciple: As between UPS and FedEx, and all these companies are always grouped together, UPS, Amazon is 13% of the business, FedEx is leaving doing business with Amazon. As between these two companies, which did you find more interesting?
Whiteman: FedEx had a tough year in 2019, in part it was it's own doing. They were really investing heavily, they were going to seven day a week service, they were building out their infrastructure. Ended up very well-timed investment, given what came in 2020. But they are still paying the price for that, despite having a great year in 2020. You get them at a discount, right now the forward price-to-earnings, price is 18 times earnings for UPS, it's only 14 for FedEx. I think FedEx is better set up to grow margins. You're going to see better asset utilization as you go year-over-year. We're seeing that seven-day use of the assets. I think there's a real opportunity for FedEx to close that gap. FedEx is also doing a really good job. One of the reasons that they and Amazon got in such a fight is, they are going after Amazon. They are helping retailers with returns, they are doing a lot of these services to try and get the business of everyone but Amazon. I like the way FedEx is set up. FedEx's stock was gang busters in 2020, it still has room to run. They're the stock of the two I own, and I'm happy with that, I'm not switching that up anytime soon.
Sciple: Yeah. Obviously this big surge in logistics volume has been significant for lots of players in the space. Before we went away, we've talked about UPS and FedEx, I wanted to talk about one other company that should be on folks' radar, we've talked about it offline summits, it's been on the watch list for a long time. I've never bought shares, but I need to correct that sometime soon. But you do own shares at XPO Logistics, Lou, why is this a company in logistics or in shipping that people should be paying attention to?
Whiteman: Another one by the way that's had a big fight with Amazon, and then sold its stocks off. But XPO is more diversified than UPS or FedEx. It is a large logistics company. It's doing like we talked about with FedEx. It wrote the road map on how to compete with Amazon. It's XPO direct product is basically the entire back-office for retailers who aren't named Amazon, who can't maybe necessarily do that scale on their own, but collectively they can get that scale and better compete. It's also a very confusing company to follow because it's one of the largest trucking businesses, it's got a huge European operation. Quite frankly, it's stock was a real dog in the pandemic, because of the European operations, it got hit twice on the pandemic. It's got a lot more debt than its peers, because it is a 10-year roll-up story, up until the last year or two, it would've been constantly buying things. It's CEO, Brad Jacobs, back in April, basically had to write a pep rally letter to shareholders. He said, "Look, I'm a mega bull in this company long-term. We've built this company like a bullet proof tank, we're going to generate a lot of cash in the downturn." The stock has come back, but it is still a very interesting company to watch with a lot coming up this year.
Sciple: You mentioned two things; you mentioned the roll-up strategy and you mentioned Bradley Jacobs. If you look at his track record, Bradley Jacob and roll-up, he's like a hall of fame. His track record, this isn't the first of his companies that he's built. He tells you he's bullish on a company. If his track record is any proof, he's probably correct.
Whiteman: If you look at it, he said, "We will generate cash through this," because that was a real concern. They do have a lot of debt relative to their peers. The two quarters they've reported since then, they beat analyst expectations for cash both times, $200 million in the second quarter, almost $300 million in the third. The stock is up 112% since that letter. It's still arguably undervalued, and we can get into this, in December they announced plans to split into two companies. On one side, you are going to own the world's second largest contract logistics operations. This is the e-commerce focus thing. This is what we talked about, the direct product and the Amazon logistics for everybody not named Amazon. On the other side of it, you have the third largest provider of less than truckload transport in North America, which is a very lucrative part of the business. CAIDI, instead of filling a truck for one customer, putting a lot of different customers orders on a truck, so it's a lot more complex. It's also one of the second-largest freight brokerages. Hopefully by the end of this year, these will be two separate companies.
The reason is really simple, XPO trades today at an enterprise value 13 times EBITDA. If you look at some of the pure plays in these two businesses, a best-in-breed, Old Dominion is a less than truckload best-of-breed. It trades at a 21X multiple. Logistics specialist C.H. Robinson, again, a very good company, they traded 16X. XPO again was at 13X. They are hoping for a simpler story, a less confusing muddled story. They can get rid of the conglomerate discount. You can also reshuffle the debt and put more debt on the logistics side, which should be faster-growing and hopefully achieve investment-grade for both. I really believe for all of the gains the stock has made, it is still undervalued, it is still the most interesting thing out there. When this split happens, it's going to be really interesting to see what Jacobs does next and where it goes from here. Because when you give him a currency, when you give him freedom to go out and explore and buy things, as you say, he has a wonderful track record of creating value and I have no doubt he'll do it again.
Sciple: As you're talking Lou, it reminds me. I think it was a year or a year and a half ago, we talked about the DowDuPont split and how the management in that case had a great track record of creating value. You have a similar situation where you have this event, where you have a manager with a track record of allocating capital and creating value with the way they've moved things around. You can tell a story about why from a fundamental point of view, this business has lots of tailwinds, and you could tell a story just from a valuation point of view, if you just snap your fingers and close that valuation gap, the company can really produce gains for you. I don't know, there's a lot to like about XPO, I think, and I've watched it for far too long. I think maybe it's about time for me to buy a few shares.
Whiteman: One more thing too, if you just think of the psychology, and it is all too common for an empire builder to fall in love with his empire. I think it shows almost heartlessness, and I mean that in a good way, but a ruthless commitment to shareholder value, to rip what you have created in half, because the market in your mind doesn't recognize the value. Part of me is a long-term holder, I'm OK. I intend to hold it forever. I sometimes think, "Man, this is a good business. I wish they'd keep it together and figure it out." But you really have to appreciate him, the guy who built it saying, "No, it's not working. I am going to do this dramatic thing because this isn't working." Again, as far as a CEO, this is a back the jockey played for me and it's so far so good.
Sciple: We'll see what happens there. Lou, before I let you go, I want to ask you the highlander question. We've talked about a bunch of companies today. There can only be one that you're going to choose. We mentioned Amazon briefly, I'll throw Amazon in there. UPS, XPO, SpaceX, Boeing, you can only own one for the next five years. Which one are you choosing and why?
Whiteman: I think I maybe already answered this, but I am definitely taking XPO. I have high hopes for all those companies, SpaceX, I doubt we'll ever see public, but XPO, I just think there's so much potential, especially on the logistics side, to grow as e-commerce becomes more important. On the trucking side, I think we're going to see this become one of the best operators. Again, it's a pretty fragmented industry, it can continue to grow. I think there is a lot of room to run. None of these are tech companies, Amazon is a tech company. But as far as industries go with growth rates, XPO is a really intriguing story for me. I think that's where I'd go.
Sciple: Maybe I've telegraphed which one I'd pick, because I've watched XPO just go up for the past couple of years and there's been several times when I've looked at the company and said, I can tell myself a story about why this valuation makes a lot of sense and I've never actually bought and so I think I'm just going to stop being dumb and actually buy. For me, I'm going to pick XPO. But we'll keep following this company then the whole space as things evolve and as the spin takes place, we'll talk about that when that time comes. Until then, Lou, thanks as always for joining me.
Whiteman: Always a pleasure.
Sciple: As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against the stocks discussed, so don't buy or sell anything based solely on what you hear. Thanks to Tim Sparks for mixing the show. For Lou Whiteman, I'm Nick Sciple. Thanks for listening and Fool on!
