It was a rough six months for XPO Logistics (XPO -0.16%) coming into its fourth-quarter earnings report.
The stock has underperformed since it spun off GXO Logistics, its contract logistics division, in August, and shares fell after it released its third-quarter earnings report in November. Challenges in its less-than-truckload (LTL) segment due to driver shortages and some poor strategic decisions weighed on margins and pushed the stock lower, but the transportation powerhouse reasserted itself in the fourth quarter.
XPO shares gained 8.3% Wednesday as the company beat estimates on the top and bottom lines, and issued strong guidance for 2022. Below are some of the highlights:
- Revenue rose 14% to $3.36 billion, the highest revenue for any quarter in the company's history, beating estimates at $3.27 billion.
- Adjusted EBITDA rose 12% to $323 million, and adjusted earnings per share came in at $1.34, ahead of the consensus at $0.99.
- For 2022, the company expects adjusted EBITDA of $1.36 billion-$1.4 billion, an increase of 11% at the midpoint, and adjusted EPS of $5.00-$5.45, up from $4.30 in 2021.
With supply chain challenges cramping much of the global transportation system, XPO is continuing to deliver solid growth. Here are the three areas to watch with XPO this year.
1. The LTL recovery
Historically, investor focus has been primarily on the LTL segment, as it generates a majority of the company's profit and has been its biggest growth driver. Before the pandemic, CEO Brad Jacobs had even proposed selling all of the business segments except LTL, but that plan changed after the pandemic started and led to the GXO spin-off.
In the third quarter, the company ran into a number of challenges in the less-than-truckload division as a mounting backload, which stemmed from a driver shortage, eventually lead the company to pause operations and some of its docking facilities. The company struggled to fulfill demand, which weighed on margins. In the third quarter, adjusted operating ratio, which is expenses divided by revenue, rose to 84.4% (excluding real estate gains ), and again rose to 87.5% in the fourth quarter.
However, the company said it took a number of strategic actions, including ramping up training at its driver schools to bring on new drivers and opening new facilities to add capacity, and that performance has improved every month from October onward. It now expects its operating ratio to improve on a year-over-year basis by the middle of 2022, and for the full year, it's targeting at least 100 basis points in operating ratio improvement.
Executing on that goal will be key to the company's success this year, as weakness in LTL seems to be the market's biggest concern right now.
2. The impact of XPO Connect
XPO said that its second-biggest segment, truck brokerage, continued to gain market share thanks to the strength of XPO Connect, its Uber-like app that connects drivers with shippers, disrupting an order process that was typically done by phone just a few years ago. XPO Connect passed 600,000 total downloads two weeks ago, more than doubling in the last year.
That app provides both network advantages and scale advantages, and it should help drive an increase in truck brokerage margins over time, as the incremental cost of booking an order through Connect is minimal.
The company said that brokerage loads increased 29% in 2021, and that 70% of brokerage orders were created or covered digitally, showing that Connect is driving much of that growth.
XPO is calling for double-digit volume growth in North American truck brokerage annually from 2022 onward, and Connect plays a key role in that growth, as it creates barriers to entry and keeps customers in its ecosystem. Investors should keep an eye on the number of downloads of the app going forward. As Connect proliferates, the truck brokerage business should prosper.
3. Improving its debt ratio
For several years, XPO has targeted an investment-grade credit rating. The company has repeatedly heard from its investor base that this is a major reason why it's trading at a discount to its peers. XPO took on a lot of debt in its roll-up years when it was rapidly acquiring transportation companies, and more recently to help fund share buybacks.
Currently, the stock is trading with a debt/EBITDA ratio of 2.7, as it has $3.3 billion in debt and finished the year with $1.24 billion in adjusted EBITDA. The company aims to bring that ratio down to 1x-2x by the first half of 2023. If it hits its adjusted EBITDA range of $1.36 billion-$1.4 billion, the company will have to slash its debt by at least $500 million this year.
Since reaching an investment-grade credit rating has been a long-standing goal of the company, investors should expect the company to prioritize it. Keep an eye on debt reduction over 2022, as reducing its debt will not only help it gain an investment-grade rating, but also help reduce interest expenses, which ate up a third of operating income in 2021.
What's next for XPO
Trading at a price-to-earnings ratio of 14 based on this year's guidance, the stock looks like a value play, especially if it can execute on the three points above. As a trucking company, XPO is also in a unique position as a company that benefits from the global supply chain constraints, which have generally raised prices for transportation. As XPO vice president of strategy Aroon Amarnani said in an interview with the Motley Fool, "It's a good time to be a transportation company."
With the macro tailwinds behind it, the stock should reward investors over the next year if it can hit its leverage goals, improve LTL margins, and continue to ramp up growth at XPO Connect.