The two key ratings agencies have weighed in with a cautionary outlook on the offer by GXO to acquire U.K.-based contract logistics company Wincanton.
Neither Moody’s nor S&P Global Ratings reduced its credit rating on GXO (NYSE: GXO). At Moody’s, the Ba1 corporate rating is one notch below investment-grade. The S&P Global (NYSE: SPGI) rating of BBB- is the lowest investment-grade rating.
But both agencies put GXO on the equivalent of a watch list because of the additional debt the company will be taking on to acquire Wincanton. At S&P, that means the outlook for GXO goes to negative from stable; at Moody’s (NYSE: MCO), the proposed $971 million acquisition was declared “credit negative.”
However, Moody’s still has a “positive” outlook on GXO. Despite the financial issues raised in the report, that outlook remains in place and is not negated by the credit-negative declaration.
The Wincanton board has recommended shareholders approve the GXO offer, rejecting an earlier deal to be acquired by Ceva Logistics.
The concerns expressed by the ratings agencies are not that the acquisition is necessarily a bad move. They are driven completely by the resulting credit metrics.
As S&P Global wrote, “we believe Wincanton will strengthen GXO’s market position in the U.K. As of the close of the transaction, the company will become the largest contract logistics provider in the U.K.”
But GXO is taking on about $1 billion in new debt, and that has altered the credit metrics the two agencies use in reviewing companies with publicly traded debt, though not enough to affect the actual ratings.
Moody’s said it moved the company to credit negative because the acquisition “is expected to be entirely debt funded.”
Its estimates on the deal are that based on the price to be paid for Wincanton, the ratio of debt to earnings before interest, taxes, depreciation and amortizaztion at GXO at the close of last year would have been about 3.2X. The actual ratio was 2.8X.
But the increase is relatively in line with what Moody’s had seen as the range of EBITDA ratios “expected over the near term.”
The positive outlook for GXO at Moody’s means that conditions could allow for an increase in its rating, particularly important at Moody’s since a one-step improvement there would boost GXO’s rating to investment grade, where the S&P rating already resides.
Investment grade from Moody’s will likely need to wait
Moody’s said the increase in debt levels at GXO because of the Wincanton acquisition “will likely delay the time period for a possible upgrade to investment grade.” But it expressed further support for the long-term impact of the deal, saying GXO “will be able to realize synergies from the transaction and use its free cash flow to delever over 12-18 months following the acquisition.”
Optimism for the longer term
“The acquisition of Wincanton will help enhance GXO’s size and scale in the UK market as well as expand its offerings to sectors like defense and infrastructure in which GXO previously did not have a large presence.” Moody’s said.
S&P noted that EBITDA margins at Wincanton were about 200 basis points less than those at GXO. Margins at the combined company may drop in the short term, S&P said. “However, we expect management will realize its identified cost synergies over the next 2-3 years, which will improve GXO’s profitability and margins toward its historical levels,” S&P said.
Other statistics were spelled out by S&P in its decision to change the outlook to negative. As a result of the deal, GXO’s funds from operations (FFO), a key debt metric, will drop to 28% for 2024, below the threshold of 30% that S&P has established to be considered BBB-. But S&P also said it believes that FFO will increase to about 30% by the end of 2025.
On an outright basis, GXO debt based on S&P calculations will increase to about $4.9 billion, including leases, when the deal is complete, up from $3.6 billion at the end of 2023. “We do not expect the acquired earnings from the acquisition will be sufficient to offset its effect on the company’s leverage,” S&P said.
The $1 billion in new debt GXO is taking on will also come with what S&P said was about $256 million of leases Wincanton now holds.
The Wincanton acquisition will have a significant impact on debt levels that GXO management had said were the company’s goals. According to S&P, management had said it had a net leverage target of 1X-1.5X, which the ratings agency said translates to its own benchmark of about 2.2X to 2.4X. With the Wincanton deal, that number will rise to about 3.1X based on the S&P scale.
“We expect GXO’s leverage will remain above its target range for the next 12-24 months,” S&P said. “In addition, management has not completely ruled out opportunistic share repurchases despite its elevated post-acquisition debt profile. As such, we believe there is sufficient uncertainty regarding GXO’s willingness to restore its credit measures to levels we view as appropriate for the rating on a sustained basis.”
A spokesman for GXO declined comment on the ratings agencies’ actions.
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