The ratings analysts at S&P Global knew that XPO Logistics (NYSE: XPO) had lost a major customer when they reviewed the company’s debt rating in late February. But it didn’t make a difference; the logistics company’s rating was held at BB.
In an interview with FreightWaves, Edward Murphy-Schwartz, the S&P Global ratings analyst that covers XPO, said the rating had come out after XPO Logistics announced the loss of its customer, “so it [S&P Global’s rating] does incorporate that,” he said.
The two announcements – the XPO ratings call during which the loss of the customer was announced and the S&P affirmation of the BB rating – came close together. Given that the ratings process at S&P is deliberate and has become more deliberate in recent years, it was not certain that that the BB rating did include the news about the lost customer, but Murphy-Schwartz confirmed that it did. (A listing of S&P Ratings’ categories and what they signify can be found here.)
In releasing its fourth quarter earnings, XPO said it had lost a customer that was spending $600 million annually. The identity of that customer was never confirmed but all assume it was Amazon (NASDAQ: AMZN) .
A BB rating is not considered investment grade. But in affirming that rating, Murphy-Schwartz and other analysts at the S&P wrote said that while they expect XPO Logistics’ debt-to- EBITDA rating would weaken, the changes were relatively minor. S&P Ratings took the action while rating a new debt offering of $1 billion that XPO Logistics intends to use to buy back stock.
Spreads on high-yield debt have been narrowing in recent months as this chart shows, reflecting the spreads between a benchmark Treasury number and a basket of high-yield debt.
“We believe debt to EBITDA will increase to the low 3X area and [funds from operations] to debt will decline to the low 20 percent areas in 2019,” S&P said in its announcement of the rating. “We assume that any additional buybacks will be financed with internally generated cash flow and the company will use excess cash thereafter to repay debt.”
Although both those developments would mark a weakening, those metrics “will remain commensurate with the ratings.” XPO’s debt could be lowered if the debt to EBITDA rating went above 4X and the funds from operations to debt dropped to less than 20 percent, the ratings announcement said.
XPO was first increased to a BB rating in the summer of 2018. At that time, S&P Ratings said of the company that it expected XPO’s debt to EBITDA ratio to rise to the mid 2X area in 2018 from 3X in 2017, and that the funds from operations (FFO) to debt ratio would rise to the low 30 percent range for 2018 from 24 percent in 2017. What S&P Ratings is looking for now marks a backward step from those projections.
Murphy-Schwartz said there are few companies S&P Ratings rates that are a direct comparison to XPO. The closest he could cite was C.H. Robinson (NASDAQ: CHRW), which carries a debt rating of BBB+. That is investment grade, unlike the BB carried by XPO.
There are several smaller logistics companies owned by private equity with a lot of debt behind them. “They are more highly leveraged than XPO so they would all be in the single B category,” Murphy-Schwartz said.
Murphy-Schwartz was asked about the strategy to go into debt to repurchase shares and whether it was unique. He noted that it marked a shift for XPO which he said had been “fairly aggressive” in the acquisitions area during the past few years. “Now they’re shifting their focus to stock repurchases,” he said. “It’s certainly not a credit positive, but the company has the capability to do that.” The affirmation of the BB rating is a sign of that belief, he added.