This is the year of artificial intelligence (AI) on the stock market as a number of AI stocks have skyrocketed so far in 2023 on excitement over ChatGPT and generative AI. But not every big winner has to do with the technology.
Take XPO (XPO 0.29%), the less-than-truckload (LTL) transportation company that became a pure play in that sector following the spinoff of GXO Logistics, its former contract logistics arm, and RXO, its former truck brokerage division.
Following a pop on its earnings report on Friday, the stock is now up 114% year to date, and essentially all of those gains have come over the last three months.
A new opportunity
XPO slumped through 2022 and early 2023. Trucking is a cyclical business, and demand has been soft amid fears of a recession and a slowdown in retail demand following the pandemic as consumer spending has shifted to services like travel.
However, in the first two quarters, the company has executed on virtually all of its strategic priorities, including improving customer service with better on-time rates and lower damage ratios, reducing purchased transportation costs, improving labor productivity, expanding capacity, and gaining market share.
In the second quarter, XPO improved on most key metrics from the first quarter, though year-over-year comparisons were more difficult.
Revenue in the quarter fell 6.4% to $1.92 billion, though that decline was almost entirely due to lower fuel surcharges, and shipments per day rose year over year. Adjusted operating ratio, a key metric in the industry that is the inverse of operating margin, rose from 83.2% to 87.6% year over year, but improved sequentially, and the company is still aiming to bring the operating ratio down to 80% over the next few years.
The key to doing that is improving customer service so it can raise prices and avoid excess costs for things like damages. On the bottom line, adjusted earnings per share fell from $1.14 to $0.71, but that beat estimates at $0.62.
Management also said that demand had hit a trough in March and was starting to recover as the economy appears to be bouncing back.
There's also a wild card in the LTL industry (carriers that take an assortment of merchants' deliveries in each truckload instead of full loads from one company) with the bankruptcy of Yellow, the nation's third-largest LTL carrier. XPO Management commented on its earnings call that approximately 10% of capacity is being removed from the domestic industry with the bankruptcy of Yellow, which should naturally lift prices in the industry.
Based on July data, XPO already seems to be benefiting from Yellow's collapse as tonnage rose 4% and shipments per day rose 9%.
Management said that it would be judicious about adding freight, sticking to its pricing and capacity goals.
Is XPO a buy?
Three factors seem to be driving XPO stock higher this year. First, the company is making progress in its strategic goals and continuing to expand capacity. For example, it said that its damage-claims ratio fell to 0.7% in the second quarter, which was its lowest level in seven years.
Second, cyclical stocks like XPO are starting to recover as investors bet that the worst of the economic slowdown is behind it. Management's comments about the demand trough taking place in March back that up, as does broader economic data showing inflation coming down, unemployment remaining low, and the strong recovery in the stock market this year.
Third, the Yellow bankruptcy is a clear opportunity for carriers like XPO, Saia, and Old Dominion Freight Lines, which have all gained on the news. XPO and its peers will almost certainly pick up market share from the removal of a major competitor, and pricing in the industry is likely to move higher without Yellow's capacity or competition.
Once the economic expansion picks up, XPO stock has a lot of upside potential if it can continue to make strategic improvements and capitalize on the Yellow bankruptcy.