XPO Logistics Leveraging A Hot Freight And Logistics Market - xpo, Seeking Alpha

Logistics xpo. Stephen Simpson, CFA. XPO Logistics Leveraging A Hot Freight And Logistics Market. Jun. 19, 2018 2:53 PM • xpo. Summary. Strong demand for forwarding, brokerage, trucking, contract logistics, and last-mile fulfillment is fueling double-digit revenue growth. Last mile remains an attractive growth opportunity on expanding e-commerce volumes and a desire for customers to use alternatives to Amazon. Even high teens compound FCF growth isn't enough to support an attractive fair value, but XPO gives investors the occasional pullback-driven second chance. One of the pleasures of following XPO Logistics (XPO) has been listening to the various and sundry comment section prophets of doom call for XPO's imminent collapse - back at $30, $50, $75, and so on. There have most definitely been some big corrections along the way, but management has demonstrated that not only can it assemble a high-quality broad-ranging freight and logistics franchise but also run it well. A debt-rich balance sheet, economic sensitivity, and a desire for more deals are all risk factors to varying degrees, but XPO has carved out strong positions in areas like truck brokerage, forwarding, less-than-truckload (or LTL) trucking, last mile logistics, and contract logistics. Valuation is a much more significant issue for me now, though. Even if XPO Logistics can grow at a pace similar to what companies like Old Dominion (ODFL), J.B. Hunt (JBHT), Hub Group (HUBG), and C.H. Robinson (CHRW) have managed and push FCF margins into the mid-single-digits, the implied returns aren't that impressive, and the shares are likewise not all that cheap on a forward EV/EBTIDA business compared to a blended multiple based upon its end-market exposures. Closing The Gap. One of the older bear theses on XPO Logistics was that management could assemble the various parts and pieces of a freight and logistics empire, but it would struggle to run them. Although not all of the parts and pieces of XPO have been equally successful, I believe the LTL trucking business (Con-Way) is a good example of what management can do. Con-Way had unimpressive operating ratios in the mid-90%'s when XPO acquired the business (while Old Dominion was in the mid-80%'s). Now the operating ratio has improved into the high 80%'s, which is still worse than Old Dominion's, but nevertheless better than several competing LTL truckers. XPO has also shown it can be flexible and opportunistic with its freight brokerage business. Taking advantage of a tougher capacity environment, XPO has successfully pushed its business more in the direction of spot business, helping drive 30%-plus revenue growth in recent quarters. Focusing On Last Mile … And Not Being Amazon. Last mile logistics have become one of the more appealing market segments for XPO. A roughly $13 billion market growing meaningfully faster than GDP, XPO has more than doubled its market share over the last few years and built its share into the high single-digits, well above competitors like J.B. Hunt and ArcBest (ARCB). Last-mile service growth continues to be pushed by growing e-commerce, and particularly with/for heavy and bulky objects ordered online. XPO is also benefitting from demand for retailers leering of handing over too much of their logistics to Amazon (AMZN) (which is also a last-mile client of XPO). A key challenge for e-commerce operations is facilitating quick fulfillment without building an expensive network of distribution centers and other logistics infrastructure. The latest solution from XPO, XPO Direct, looks to address that with a flexible distribution model that provides warehouses, hubs, and cross-docks on a flexible shared-space model, with XPO also providing delivery/transportation capacity either through its own fleet or through brokered/contracted capacity from other providers. And Now? A healthy economy usually makes for a healthy freight environment, and XPO is benefiting from strong demand for trucking, forwarding, brokerage, contract logistics, and intermodal services. XPO has logged two straight quarters of double-digit organic growth, and segment-level margin leverage is starting to come around as well. With 36% growth in the sales pipeline in the first quarter, I don't believe XPO is going to have many near-term problems with its volume. Management has also been signaling that it intends to do more M&A. As is typical for the company, it doesn't seem like management is restricting its interests to specific market segments, but it does want a company that has a global presence with operations in multiple geographies. Management also seems more demanding on the return hurdles for a deal, and higher valuations across the sector may be getting in the way of closing a deal. The Opportunity. Between freight brokerage, freight forwarding, contract logistics, and intermodal, there are plenty of growth opportunities in established markets for XPO, not to mention meaningfully growth potential in leveraging expanding last-mile opportunities. XPO is pretty balanced between asset-light and asset-based today, and I can see growth arguments for both sides of the business (freight forwarding being asset-light, while contract logistics and last mile can require more assets). I believe XPO Logistics can generate high single-digit revenue growth from here, with both organic growth and M&A driving the business. I do expect better FCF margins from here, and I think the asset-based and asset-light models will balance out at roughly mid-single-digit long-term FCF margins. There's more variability/risk with this part of the model, though, as a greater shift in either direction would certainly skew the future model. As is, though, I expect very healthy high teens FCF growth from here. Unfortunately, none of those assumptions supports a compelling fair value from here, and the forward EBITDA multiple is already demanding. The Bottom Line. XPO has provided several second chances over the years (10%-plus pullbacks), and I won't be surprised to see another one at some point, whether it's from a quarterly miss, an unpopular acquisition, or what have you. The frustrating question is when that second chance comes and how much higher the stock goes before it pulls back. I'm not interested in chasing the shares at this price, but XPO has built a track record of proving its doubters wrong and I believe the company's diversified freight and logistics business is well-placed to benefit from ongoing growth in outsourced logistics and e-commerce.