XPO Logistics announced this morning it will repurchase up to $1 billion of its common stock under a plan authorized by its board of directors. Deutsche Bank (DB) analyst Amit Mehrotra, meanwhile, has placed a buy rating on the company’s stock, as has Stifel, following a negative research note from noted short-seller Spruce Point Capital Management.
“To be sure, we are not forensic accountants, but there are enough inaccuracies in the report, and highly misleading analysis – especially with respect to the cash flow – to make us feel today’s sell-off could ultimately be seen as one of the great buying opportunities,” Mehrotra wrote. “We understand the difficulty in timing, given broader macro concern and lackluster guidance, but ultimately, we feel this short report will be remembered for its inaccuracies rather than its soundness.”
XPO did not elaborate on the share repurchase program or whether it had been in the works prior to the Spruce Point report. In a release, the company said it would fund the repurchase through a variety of methods, including “existing cash, borrowings on XPO’s revolving credit facility and/or other financing sources.”
XPO’s (NYSE: XPO) stock tumbled on Thursday following the Spruce Point report, finishing the day down $15.78, off 26.18% to close at $44.49. It opened this morning at $59.94 before sliding back a bit and was at $47.02 during mid-morning trading, a more than 5% increase from yesterday’s close.
Mehrotra’s research note included counter arguments to the main points of the Spruce Point report, saying that DB had found no “smoking gun” that would lead to the conclusion of Spruce Point’s Ben Axler that XPO was providing no “tangible financial return” to investors.
On a point-by-point basis, Mehrotra attacked Axler’s main points, including his claim that XPO was overstating its total enterprise value. “It appears the report is double counting secured debt of $2.1B…implying EV under its own definition is $15.1B vs. $17.2B as stated in the presentation. This error translates to over 1 turn of valuation, which would directly counter the conclusion that ‘XPO is more expensive than it appears.’”
Axler also claimed that free cash flow was only $73 million on over $6.1 billion in capital deployed. This fails to include proceeds from asset sales, Mehrotra said, which is standard in trucking-related companies. “This would add $79M to FCF in ’17 and $69M in 2016, and more than triple the report’s estimate of ‘cumulative free cash flow,’” Mehrotra noted.
Mehrotra went on to point out that Spruce Point compares leveraged free cash flow to enterprise value and it ignores inflows expected in the fourth quarter of 2018. “This … is most indicative of our overall impression of the report, which cherry picks cash flows to reach misleading conclusions together with calculation errors,” Mehrotra said.
The DB note also counters the claim of external financing, noting that Axler ignores the fact that XPO has paid down $1.8B in gross debt while issuing $635M in equity, “implying $1.2B of debt was paid down using internally generated cash (the majority of which is via FCF with the rest from the sale of the TL business in late ’16).”
Mehrotra added that DB is estimating XPO will grow its cash balance by $250M from 2016 to 2018, meaning that it will have generated over $1.5B of cash over this period.
Spruce Point also declared that there was a 9% organic decline in operating cash flow, but Mehrotra points out that this is a calculating error. The report compared operating cash flow in 2017 to 2018, he wrote, rather than 2018 to 2017. Done the latter way, organic operating cash flow growth increased 11% and DB believes that cash flow from operations will exceed 30% in 2018 versus a 10% organic revenue growth.
Another error is identified when Spruce Point says that XPO reported organic growth from the sale of its truckload operations in 2016 that was off by $40M which resulted in lower organic growth revenue of 300 bps. In reality, Mehrotra wrote, the discrepancy was just 30 bps, not 300, and while this is an error, the “modest discrepancy is entirely explained by fuel and inter-company eliminations (i.e. gross vs. net).”
Finally, Spruce Point highlighted the differences between “book taxes” and “cash taxes” and the impact this has on XPO’s earnings per share.
“It claims that XPO has overstated its EPS vis-à-vis $132M of tax benefits to book earnings, while cash taxes have been a $182M outflow,” Mehrotra wrote. “It is entirely common for industrials companies to have differences in book vs. cash taxes given the treatment of depreciation (straight line on the IS vs. accelerated for cash tax purposes). More recently, the reverse is actually true…i.e. book taxes exceeded cash taxes, implying under this same methodology that XPO is under-stating its true earnings power.”
Stifel has placed a price target on XPO stock of $98 and reiterated its buy recommendation.
“XPO has been hit especially hard as skittish investors abandon their perception of the company as an asset-light growth play and begin to handicap it for its cyclical, asset-heavy leanings,” Stifel’s Bruce Chan noted. “But even if you value the entire company like a (non-union) LTL, we believe it still looks attractive. Which is not to say that we think a trough LTL valuation is necessarily reasonable; freight market fundamentals remain strong and the company remains one of the best and most capable problem solvers in an increasingly complex supply chain environment. Could management have been more careful with its guidance (acquisitions, EBITDA, and otherwise)? Perhaps. But do we think 12%-15% EBITDA growth (even if less than before) portends disaster? No. Reiterate Buy.”