RXO has carried an investment-grade rating from Moody’s Investors Service since the fall of 2022, when the 3PL was spun off from XPO (NYSE: XPO).
But it is now under threat as Moody’s has changed its outlook on RXO (NYSE: RXO) to negative from stable.
At the same time, Moody’s affirmed that initial investment-grade rating of Baa3 given in 2022. The Moody’s rating is particularly notable — and valuable — to RXO because the company’s rating at competing ratings agency S&P Global (NYSE: SPGI) is BB+, one notch below investment grade.
The report by Moody’s (NYSE: MCO) attributes the weaker outlook directly to the state of the freight market. “The negative outlook reflects Moody’s view that RXO’s credit metrics will be weak through the remainder of 2024 given the prolonged weakness in the freight transportation sector that will not improve materially until the second half of 2024,” the ratings agency writes.
A key metric for the ratings agencies is debt to earnings before interest, taxes, depreciation and amortization. Moody’s said it believes that ratio at RXO will remain above 2.5X for the next 12 months.
In discussing the possibility of upgrading the Baa3 rating, the agency said it would need to see the 3PL “sustaining debt-to-EBITDA below 2.0X.”
But the rating could be downgraded if the 2.5X ratio is “sustained” for an unspecified period of time. A downgrade would put the Moody’s rating into non-investment-grade territory.
The report reflected the pessimism that would be expected given the lowering of the outlook to negative.
“Moody’s believes that increasing freight volumes in the second half of 2024 will result in improvements in both leverage and liquidity given the highly variable cost structure of RXO,” it wrote. “However, any delay in a turnaround in the transport market will keep RXO’s metrics outside of its downgrade factors until early 2025 and limit the company’s ability to absorb negative developments at the current rating level.”
When RXO announced its earnings for the first quarter of 2023, it posted numbers that seemed to defy a weak freight market that was hitting the bottom line of both carriers and 3PLs. But its earnings in the fourth quarter of the year reflected the same challenging freight market as other companies facing tough market conditions.
RXO’s stock in the past 52 weeks is up 12.52%, though in the most recent three months it is down 13.2%. That has far outpaced peer company C.H. Robinson (NASDAQ: CHRW), which in the past year is down 22.4% and in the most recent three months is down 15.1%.
C.H. Robinson has an investment-grade BBB+ rating from S&P Global and a negative outlook. Moody’s rating of C.H. Robinson is Baa2 with a stable outlook. Baa2 is also investment grade but is considered a notch down from the BBB+ rating of S&P.
(The investment-grade credit rating at C.H. Robinson, which has been in place for several years, is important enough to the company that it has been brought up by management on earnings calls with analysts several times in the recent past. In November, discussing third-quarter earnings at C.H. Robinson, CFO Mike Zechmeister said “our capital allocation strategy is grounded in maintaining investment grade credit rating which allows us to optimize our weighted average cost of capital.”)
Asked to comment on the report, a spokesperson for RXO said, “The entire industry continues to feel the effects of the prolonged soft freight market. RXO maintains an investment-grade rating with Moody’s and is well-positioned to continue to outperform and deliver rapid earnings growth when the market turns. “
The weak market has affected covenants with some of RXO’s lenders, Moody’s said. Its failure to reach net leverage covenants has limited its access to its $600 million revolving credit facility, Moody’s said, with access to only about $160 million. However, Moody’s also noted that RXO generally doesn’t rely on its revolver to fund operations.
Moody’s sees RXO’s management as tackling its issues but confronting macroeconomic issues that it can’t control. “There are several actions that management is taking that will improve profitability in 2024 that don’t rely on an improvement in market fundamentals,” Moody’s wrote. “However, a shrinking of excess carrier capacity and an improvement in brokerage volume will ultimately be necessary to return to growth in profitability.”
And in an unusual reference to the relatively brief history of RXO, Moody’s said in discussing the possibility of an upgrade of the 3PL’s credit rating: “Moody’s will be looking for the company to have a longer track record as a standalone entity and evidence in its ability to maintain performance through all points in the cycle.”
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