For the last two years, XPO (NYSE: XPO) has been in the process of breaking up the transportation and logistics behemoth it had become via multiple acquisitions over the last decade. However, the final piece — the sale of its European Transportation unit — was pulled earlier this month due to “weakened capital markets in Europe.”
“[We] stopped the process and we’re not going to be selling the business here in the near term,” new CEO Mario Harik told FreightWaves, noting the unit continues to perform well, recording mid-single digit organic growth “despite the macro softness in Europe.”
XPO was successful in spinning off its brokerage unit RXO (NYSE: RXO) last month and contract logistics business GXO (NYSE: GXO) last year. It also sold an intermodal unit in March.
Management was hopeful it would be able to unload the European business to solidify XPO as a less-than-truckload pure-play and further enhance shareholder value by shedding what it previously described as a “conglomerate’s discount.”
However, for now, XPO is “predominantly a [$4.5 billion] North American LTL company,” according to Harik,, with a $3 billion transportation business in Europe. Europe only accounts for roughly 15% of consolidated earnings before interest, taxes, depreciation and amortization. While it may be carrying some extra weight, ambitions around the LTL business haven’t changed.
“The focus of the management team and the leadership team is predominantly on our LTL business and how we can execute on our LTL 2.0 plan, which is effectively investing more capital into the business, gaining market share, leaning on price, leaning on technology, improving efficiency, and growing both top line, bottom line and expanding margins over the next five years,” Harik said.
Capacity investments allowing XPO to take market share
XPO has seen a stark contrast in tonnage results compared to most of its peers.
The carrier’s daily tonnage turned positive year over year (y/y) in September and was up again in October. Its fourth-quarter guidance, provided on the third-quarter call at the end of October, also calls for tonnage to be up y/y. Conversely, many carriers in the industry saw volumes turn negative in September with the y/y declines expanding significantly by November.
XPO is working with easier comps as it recorded y/y tonnage declines in each of the past four quarters. However, Harik credits capital investments throughout the network as a catalyst for capturing share.
The company opened six terminals over the last year, including a 99-door site in Atlanta. The opening allowed it to grow tonnage 38% y/y in that market during September. It has plans to add a total of 900 doors net, a 6% capacity increase, by the end of 2023. Through the end of the third quarter, it had net additions of 369 doors.
“We’re expanding the network, but we’re seeing that demand from the customers,” Harik said.
XPO is also investing in its trailer manufacturing capabilities, which will help it grow the linehaul and pickup and delivery fleets. Second and third production lines were added this year. The company plans to increase trailer production by 50% next year from an expected output of 4,700 units this year.
Harik said “adding capacity ahead of demand” produced the share growth in recent months. The company doubled its capital expenditures budget to a range of 9% to 10% of revenue this year and plans to deploy 8% to 12% of revenue to capital projects in the years to come. The new long-term target is in line with the amount of capital best-in-class carriers put back into their businesses each year.
XPO will also purchase tractors to lower the fleet age and add equipment where needed. It will train roughly 1,700 drivers at its 130 schools this year.
“So, when we deploy more capital into the business, we can say ‘yes’ more often to customers,” Harik said.
Another catalyst for growth has come from a 7% increase to the company’s sales force. The group brought on several large customers during the third quarter that Harik is hopeful will become top-10 accounts over time.
Service improvements creating share wins too
Some industry participants have pointed to periods of underinvestment in XPO’s LTL unit, with capex equaling only mid-single-digit percentages of revenue, as the culprit for past service issues. Admittedly, Harik said the company deployed a maintenance capex strategy in the past, refreshing the fleet regularly but not adding the infrastructure needed to take market share.
However, the strategy of late has been to commit the capital needed to the LTL business to push service levels and pricing higher.
“When you think of our capital allocation, [the] No. 1 use of capital is going to be deploying it back into the business given that we have a 35% ROIC,” Harik said.
A key service metric XPO tracks is damage frequency. The number of skids arriving intact and without damage at customer locations is now back to 2016 levels. The metric improved 58% y/y in the third quarter and by 86% y/y during October.
Harik said XPO is seeing record customer satisfaction currently as its service levels continue to move “up and to the right.” He said a rating system where pictures are taken when a trailer is packed and then again at the destination has helped. A supervisor at the destination terminal rates the quality of the unit and its freight upon arrival. The feedback is used to evaluate the performance of dockworkers.
“When you think about the overall trajectory of service and customer satisfaction, customers are rewarding us by giving us more business and a bigger share of the pie of the LTL freight that they have,” he said.
Harik said XPO is on track to post service records again next year.
Long-term targets could prove conservative
Shortly ahead of the RXO spinoff, XPO provided long-term financial targets.
LTL revenue is forecast to see a compound annual growth rate (CAGR) of 6% to 8% from year-end 2021 through 2027. That would push XPO’s annual LTL revenue north of $6 billion by the end of the six-year period.
Harik said a combination of higher volumes and improved yields will drive the revenue increases.
Roughly two-thirds of XPO’s LTL revenue comes from industrial-related freight. The industry normally sees tonnage growth on par with industrial production, but Harik said overall U.S. industrial production is likely to see an uptick as manufacturers and suppliers relocate operations closer to the U.S. consumer.
Either way, he expects XPO to record volume growth that outpaces broader tonnage gains given planned capacity investments.
Yields normally grow by low-single-digit percentages in soft markets and by high-single to low-double digits in up cycles. The industry is heavily consolidated with the top 5 carriers controlling slightly more than half of the revenue and the top 10 generating three-quarters. High barriers to entry including large capital requirements — a network of terminals, multiple equipment types, technology and operational expertise — deter new entrants, allowing long-term incumbents to remain price disciplined.
Even with the broader pullback in LTL demand, Harik said “we continue to see firm pricing dynamics in the industry and rational pricing associated with that.”
The company is using a new contractual pricing platform, allowing it to more easily set customer-specific rates, which it says has a direct correlation to RFP win rates. It is also deploying dynamic pricing capabilities more widely throughout the business, permitting it to balance price with available lane capacity on a daily basis.
XPO’s fourth-quarter guidance calls for a low- to mid-single digit percentage increase in yields (excluding fuel surcharges). That’s in the face of headwinds like a plus-11% comp last year and a later implementation of a general rate increase (GRI), likely early in the first quarter versus a November start last year.
“As we head into the beginning of the year, we’ll decide what that [GRI] would look like and based on what we’re seeing in the environment, what we’re hearing from our customers,” Harik said.
The revenue guide looks fairly subdued at first glance. The industry has captured 5% yield increases on average over the last six years, leaving XPO only needing a point or two of volume to close the gap. However, the remaining five years of the guidance period will likely include at least two downturns — the current one and another pullback at a later date if future freight cycles follow historical patterns.
Cost levers not tied to strength of macro economy
XPO has idiosyncratic cost and efficiency levers to pull, the success of which will not be determined by the macroenvironment.
The long-term guide calls for adjusted EBITDA to grow at an 11% to 13% CAGR through 2027 (guidance for LTL is $1 billion in adjusted EBITDA this year). Top-line growth accounts for a little more than half of the annual increase in EBITDA dollars with the rest coming from lower operating expenses due to technology enhancements (3 to 4 percentage points) and insourcing linehaul moves (2 points).
The all-in adjusted LTL operating ratio is expected to improve 600 basis points to approximately 82% over the same time. The unit recorded an 87.6% adjusted OR in 2021. That number excluded the impact of real estate gains and pension income and included about $80 million in previously unallocated corporate costs. XPO will begin reporting OR as an all-in adjusted number in 2023.
The tech initiatives touch all facets of the operation — pickup and delivery, dock operations and linehaul service.
The company is using machine-learning in pickup and delivery operations to automate stop sequencing and rightsize driver needs. Harik said it’s all about “cost per route or cost per hundredweight of freight that you are delivering … how much density you have on a given route. For every hour on the street, how much freight are you delivering on an overall weight basis?”
Labor efficiencies will continue to be gained through productivity tools, which grade workers at the dock level, and linehaul tech is being used to build better load plans. A better packed trailer can travel longer distances through the network and closer to final destination without being broken down and repacked multiple times. The goal is to minimize freight handling.
XPO wants to cut third-party linehaul miles in half to 12% to 14% of total miles. The cost per mile is reduced by 30% to 40% when performed in house. An 11-percentage-point reduction in outside miles would generate $55 million in savings. A 10% increase in the linehaul trailer fleet this year along with incremental capacity additions next year will facilitate the effort.
A reduction in equipment maintenance expenses will drive significant savings as well. Currently, the company is running a tractor fleet that is 5.9 years old on average. The goal is to get below five years over time to reduce expensive repairs and improve fuel economy.
All told, 1 percentage point of efficiency or cost reduction delivers $16 million of savings in the linehaul operation, $7 million in pickup and delivery and $3 million on the dock.
“When you think about the technology initiatives to improve efficiency, these have no bearing on the macro,” Harik said. “They are based on us being able to manage linehaul more effectively, pickup and delivery more effectively, dock more effectively. Obviously, we’re not immune to the macro, but most of the levers of our plan are driven by company-specific initiatives that we’re going to be driving over the next five years.”
Morgan Stanley (NYSE: MS) analyst Ravi Shanker recently told clients XPO is “squarely a show-me story” and it’s now down to execution and improved operating performance to get investors excited about the name.
“Ultimately though, it will be results and fundamentals — i.e., beats and raises — which will set the direction and ultimate multiple for the stock from here,” Shanker said.
Shaker has a favorable rating of “overweight” on XPO’s shares.
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