After successfully spinning off GXO Logistics (GXO -0.68%) last year, XPO Logistics (XPO -1.25%) is on track to run the same playbook, splitting the truck brokerage business, dubbed RXO, from the core North American less-than-truckload (LTL) business. The company sold off its intermodal business earlier this year, and plans to divest its European business ahead of the spin-off in Q4 as well, making both businesses streamlined pure plays in their respective sectors.
If there were any doubts about the overall business's performance heading into the spin-off or that the macroeconomic environment was impacting it, the latest earnings report (released last week) should put those to rest.
XPO shows a strong recovery in Q2 compared to 2021
Revenue adjusted for the sale of its intermodal business increased 10.3% to $3.23 billion, which beat estimates at $3.17 billion. The LTL business delivered a record adjusted operating ratio of 80.4%, meaning an adjusted operating margin of 19.6%, showing how profitable the LTL business has become. It also marks a strong recovery from a year ago, when the business was struggling with equipment and labor shortages as the company ramped up trailer manufacturing and hiring through its driving school to deliver record margins in LTL.
Volume in truck brokerage rose 16%, its seventh consecutive quarter of double-digit volume growth, driven by XPO Connect, its Uber-like app that connects shippers with carriers. Weekly average carrier users for XPO Connect jumped 74%.
On the bottom line, XPO delivered strong growth as well, with adjusted EBITDA up 22.7% to $405 million, and adjusted earnings per share surging from $1.22 to $1.81, ahead of estimates at $1.50.
Finally, management also raised full-year guidance for adjusted EBITDA from $1.35 billion-$1.39 billion to $1.4 billion-$1.43 billion, and it hiked adjusted earnings per share guidance from $5.20-$5.60 to $5.55-$5.90, meaning the stock trades at a forward price-to-earnings ratio of just 10. That low valuation is part of the justification for the RXO spin-off, as CEO Brad Jacobs has long argued that the stock is undervalued because of a "conglomerate discount."
Clear pricing power
The transportation industry tends to be highly sensitive to the macroeconomic environment, and indeed tonnage in XPO's LTL division did decline 5.5% from the quarter a year ago, though LTL president and incoming XPO CEO Mario Harik said on the earnings call that the volume decline was in line with the company's guidance and was actually better than its peers compared to Q1.
However, yield in LTL, meaning price excluding fuel based on weight, was up 11%, which XPO VP of Strategy Aroon Amarnani said in an interview with The Motley Fool was a good example of the company's pricing power. It also shows its ability to pass along costs in an inflationary environment.
In LTL, XPO derives pricing power because it's an essential cog in the supply chain for its customers. The recent inventory challenges in retail and other industries have underscored the need for fast and reliable transportation of goods, meaning customers will pay for a good supply chain partner. In truck brokerage, XPO is steadily gaining market share and expanding profit margins. It posted a 7.4% EBITDA margin, compared to 6.8% in the quarter a year ago, excluding the impact of the intermodal business.
Why the spin-off makes sense
XPO was built over the last 11 years largely through a roll-up strategy, meaning it grew through acquisitions. It kept the parts that made sense for its business and sold the rest. However, that made the company more complex than it needed to be, and XPO took the first step to remediate that last year with the spin-off of GXO Logistics, its former contract logistics arm.
GXO shares soared in the months after the separation before falling in the broader market sell-off, and RXO could benefit from a similar boost as it will be better able to highlight its strengths and opportunities as a stand-alone company -- just as the LTL division will, which will continue to be known as XPO.
Overall, XPO continues to execute, but a forward P/E ratio of just 10, especially with an improving leverage ratio and cash set to come in from the sale of the European business, does make the stock look undervalued. Separating the two businesses should help resolve that.