- XPO Logistics is increasingly becoming a technology company operating as a logistics and transport service provider;
- Although the overall global transport and logistics industry is worth US$1 trillion and growing at 2% p.a, sub-sectors like last mile logistics and expedite deliveries are growing at >10% driven by rising e-commerce volumes;
- In addition, a growing industry trend towards outsourcing transport and logistics requirements is providing secular tailwinds to the company’s contracting business model;
- XPO’s massive investments into technology is creating an asset-light, scalable and data driven transport and logistics ecosystem.
Once a maverick…
Bradley Jacobs has always been a maverick! During his early career days, he made money journeying and securing crude oil from outpost countries like Russia and Nigeria and chartering ships to transport it to the U.S. and Europe. But soon after getting married, his days as a globe-trotting arbitrageur quickly came to an end.
After settling back in the U.S., Bradley first went into waste collection; a fragmented but highly profitable industry. It was here where he honed the skill of acquiring and merging companies to create a lean organization whilst in the process actually realizing cost synergies; a rare feat that eludes most corporate executives. After taking United Waste public and subsequently selling it for US$2.2 billion, he moved to a new venture: heavy equipment rentals.
Applying a similar approach, Bradley invested US$35 million to take control of United Rentals and through a series of M&A, grew the company to US$15 billion in revenues before leaving again. Now at ripe age 62 years and probably in his third and final act, he is going for the home run: building a company to transform the US$1 trillion global market for moving goods.
The story of XPO Logistics dates back to 2011 when Bradley led a US$150 million investment into Express-1 (later rebranded XPO Logistics), an asset light freight broker connecting shippers with truckers. Using his one trick pony, he went on an acquisition spree snatching up several but highly complementary businesses to create one-stop logistics and transport empire offering a myriad of solutions including Last Mile Logistics, Less-Than-Truckload services, customized warehousing and distribution solutions, transport brokerage, freight forwarding and intermodal and drayage solutions.
The investment thesis is simple: Most companies either do not have the capacity to handle their logistics and transportation requirements in-house or have insufficient scale to do it cost effectively. As such, they outsource their needs to companies like XPO who offer turnkey solutions to deliver products to final customers cost effectively, on time and damage-free. Before doing a deep dive into the company, let’s look at the key macro factors driving the industry.
Industry tailwinds: The great migration to the online world
The U.S. non-food retail market is the largest in the world at US$1.7 trillion and growing at 3% p.a. driven by robust consumer demand and rising household wealth. Of that, the offline (in-store segment) is still the largest at ~US$1.4 trillion but the online segment, at ~US$300 billion, is growing rapidly at a CAGR of 15% over the next 10 years as more businesses migrate their businesses online.
With growing e-commerce volumes and highly competitive dynamics, customers have come to expect efficient and fast delivery of their purchases as a standard offering. Consequently, this is giving rise to a new phenomenon: “the last mile of the retail sales value chain” and devising a better solution to last-mile delivery is the new major battleground in e-commerce supremacy.
To stay competitive, companies have to make significant investments into building fulfilment centres and distribution capabilities required to be within 50 – 80km radius of their customers. Unless one has Amazon-like scale to do it cost effectively and the balance sheet, the only other alternative is to outsource the transport and logistics requirements to service providers who specialize in developing such massive capabilities and then on-sell “the shared logistics and transport infrastructure” to different companies. In doing so, smaller businesses can compete on equal footing with big businesses without the costly need to develop and manage their own stand-alone infrastructure.
Sub-sector tailwinds: A robust consumer durable market
XPO’s target clients are retailers and e-tailers that sell consumer durable goods: household appliances, furniture and consumer electronics. The company offers warehousing solutions, last mile distribution and other value-added services including handling customer returns, inspecting and repackaging them.
The future outlook for US consumer durable sales is strong on the back of robust private consumption driven by an improved housing market, job growth and higher wages. Total consumer durable goods sales are growing ~4.5% per annum and are expected to reach US$365 billion by 2022 with e-commerce volumes in particular growing by 15%. B2C deliveries, generated mainly by e-commerce, account for more than half of today’s volume, and will make up two-thirds of the delivery volume by 2022.
Within the different segments, sales for household appliances are expected to grow to US$130 billion, the furniture market to grow to US$125 billion and consumer electronics segment to grow to US$110 billion by 2022.
Sizing the opportunity: The rise of the Last-Mile Exchange
The rising pace of activity along the last mile of the retail sales chain reflects the booming e-commerce volumes. The U.S. is a physically vast country and to develop a logistics network that achieves geographical coverage of all zip codes is only feasible for companies with massive retail scale. Last year alone, there were ~200 million consumer durable goods deliveries and this number will grow to 340 million by 2022, according to estimates from Strategy& – PwC’s strategy consulting business. On average, a delivery cost anywhere between US$30 to US$50 depending with size and therefore assuming the mid-point, the U.S. last mile delivery segment for durable consumer goods will be worth ~US$13.6 billion by 2022 from US$8 billion this year.
Sizing the opportunity: The evolution of Less-Than-Truckload (LTL) deliveries
Uber and Airbnb pioneered the shared economy, a concept of connecting individuals to empty capacity. Interestingly, the transportation and logistics industry offer similar dynamics, specifically for in-country distribution and this is giving rise to a fast-growing segment referred to as Less-Than-Truckload (LTL). The concept is: there are companies that want to transport a quantity of freight that is larger than a parcel but too small to require an entire truck. As such, firms like XPO have built a platform, XPO Connect – an Uber for trucks, which match companies looking for “less than truckload” capacity with trucks that are traveling along their routes. Through the platforms, the carriers can locate and bid for loads along their routes and this is advantageous for two reasons:
- Truck operators can significantly reduce the distance they travel with empty or unfilled containers; and
- The matching platform also increases the capacity available to shippers who are looking to transport their goods which normally drive down prices and increase efficiencies.
As valued added services to LTL, XPO also operate several hub-and-spoke pick up points that allows for the consolidation of the multiple shipments from different shippers. LTL shipments are priced according to the weight of the freight, its commodity class and mileage within designated lanes.
The U.S. Less-Than-Truckload market is currently worth US$35 billion and growing by 4.5% per annum. The biggest opportunity is with smaller businesses who are taking advantage of the rise in shared infrastructure to drive sales across the country.
The investment case for XPO logistics: The cardinal principles
There are three key factors I consider when analysing a company:
- A growing industry with a strong sustainable tailwind, that is, the “pie is getting bigger”. The logistics and transport market in developed countries is worth US$1 trillion and growing broadly in line with GDP. However, underneath the hood, they are a number of fast-growing sub-sectors as highlighted in the table below.
|Sub-vectors||Growth outlook||XPO Logistics’ competitive positioning|
|Last Mile Logistics||10 – 12% p.a||Largest last mile logistics provider in North America|
|Intermodal and Drayage||6 – 10% p.a||Third largest intermodal provider|
|Truck brokerage, Expedite and Forwarding||4 – 8% p.a||Second largest freight brokerage
Largest manager of expedite shipment
|Contract Logistics||4 – 6% p.a.||Second largest provider|
|North America Less-Than-Truckload||4 – 6% p.a||Second largest LTL provider|
|European Transport||2 – 3% p.a||Largest provider of truck brokerage and owned fleet in Europe|
Source: XPO Logistics Investor Presentation – August 2018
- Secondly, I like companies that are taking market share within their industries, i.e. taking a bigger piece of a growing pie. Such companies have a structural right to win. XPO has an interesting hybrid business model: a high-margin asset light business segment which is complemented by an asset heavy segment which allows the company to provide an end-to-end logistics solution to its customers. Approximately 69% of the company’s revenues come from the asset light business which has a high free cashflow conversion ratio of 44% given its low fixed cost base. The balance of 31% in revenues come from the asset heavy business and management is optimising it to target a profit margin ~16%. All in all, the company’s revenues are growing at ~17% compared to ~2% for the entire industry;
- Lastly, I like companies with entrepreneurial management teams who have the right incentives and a long-term view. Bradley Jacobs epitomises such an entrepreneurial leader and has 14% ownership of the company.
Going forward, I expect XPO’s normalized revenues to grow between 10% -12% per annum on the back of high demand for outsourced transport and logistics services. Management’s efforts to optimize operating efficiencies continue to bear fruits and I expect EBITDA margins to normalize at 11% – 12% up from 9 – 10%. This compares favourably with the overall market growth and reflects how the company is creating a differentiated moat for its customers.
Future growth drivers…
Three key segments are going to drive growth for XPO going forward, namely: Last Mile and Contract Logistics driven by businesses migrating online and Less-Than-Truckload deliveries driven by the growth in shared economy.
XPO’s massive investment into technology has positioned the company to take advantage of these growth vectors. This year, the company is set to invest US$450 million into three main technology areas: 1) The XPO Connect platform in order to create scale and increase moat, 2) Deploying robots, drones and sorting system into its warehouses to increase efficiencies and lower costs and 3) Data science capabilities which are used to accurately forecast demand volumes, optimum inventory requirements and future returns volumes, key metrics essential to help e-commerce customers plan for peak inventory and workforce productivity optimization.
XPO Direct – the last mile exchange – is the company’s shared space model for retail distribution. It allows XPO’s fulfilment facilities to serve as stockholding sites and cross-docks that can be utilized by multiple e-commerce customers at the same time. This gives flexibility to smaller e-commerce players to adjust their capacity requirements in response to varying last mile demand volumes. Such a flexibility lower costs, helps them accelerate order fulfilment and reduce shipment time in transit. The table below provides projections of the Last Mile Logistics business
|Number of heavy consumer goods packages delivered in the U.S. (millions)||200||235||280||320|
|x revenue per order fulfilment||$35||$35||$35||$35|
|x revenue per delivery||$40||$40||$40||$40|
|x XPO market share||7%||7.5%||8%||8.5%|
|= Revenues (million)||$1 050||$1 320||$1 680||$2 040|
|x adjusted profit margin||10.5%||10.75%||11%||11%|
|= adjusted EBITDA (million)||$110||$142||$185||$225|
|Value of the LML business (assuming a P/EBITDA ratio of 8)||$0.9 million||$1.1 billion||$1.5 billion||$1.8 billion|
XPO is the second largest Less-Than-Truckload carrier in the U.S., covering 99% of all zip codes. The company has one of the industry’s most modern fleets, delivering approximately 20 billion pounds of freight a year and its top 25 LTL accounts use an average of six different XPO services each. There is tremendous scope of growth in this segment as technological advancements create space for a number of small businesses to grow and compete aggressively with incumbents.
In addition, XPO’s investment into developing cutting edge robotic warehouses which comprise of software and complicated modular where robots and drones pick and pack customer orders without any form of human intervention, is opening up new growth opportunities. Independent assessments have shown that robotic warehouses reduce fulfilment and logistics costs by 20% to 30% and this is fast becoming a very interesting value proposition for FMCG companies that are looking for opportunities to grow their earnings.
In June this year, XPO joined forces with Nestlé to build a $75 million highly automated logistics facility for Nescafé and Kit Kats within the U.K. where fixed robotic arms will pick goods and pack pallets, while automated drones will undertake inventory checks across high shelving units. Predictive data analytics will also deployed for workforce planning and forecasting customer orders based on weather patterns and seasons. This is the future of logistics which will increase productivity and reduce cost and will provide new opportunities to expand XPO’s addressable market.
All these factors are combining to drive XPO’s long term stock performance…
There are different type of investment styles and each rely on certain factors to drive returns. Personally, I am a long term growth investor and therefore I rely on growth in revenue and earnings to drive returns. A research by BCG and Morgan Stanley show that in the long run, revenue and profit growth accounts for ~89% of the stock performance.
Given XPO’s anticipated revenue and earnings growth of 10-12% and 15-17% respectively going forward, I believe there is tremendous upside potential in the long run.
Key risks to consider
Despite a strong long-term outlook, there are downside risks which investors should bear in mind. These include a faster than expected interest rate hikes which could hamper consumer spending in the U.S. and escalation of trade war which could increase prices for imported consumer durable goods. Also linked to the interest rates is XPO’s relatively significant debt of >US$4.4 billion which was used to finance acquisition spree.
Another key variable is the tightening contracted driver market which will increase costs. However, the impact on XPO will be somewhat reduced given that the company has its own internal fleet of 16,000 trucks.
XPO is a solid play within the transport and logistics sector to take advantage of rising e-commerce volumes. The company keeps adding ~2000 carriers to its XPO Connect platform which provides a seamless digital freight marketplace, giving shippers and carriers real-time visibility into supply and demand by geography and automates load matching. This solution is easily scalable into other markets including Canada and Europe with minimum capital investments and in addition, two-sided marketplace platforms tend to be sticky which will allow the company to shape customer experience and give it the pricing power to extract a higher share of the transport and logistics wallet.
In conclusion, I quote an excerpt from a Forbes Magazine interview with Bradley Jacobs from April 2018
“In jazz, if you hit a wrong note, there’s no such thing as a wrong note. That’s the note, that’s the reality. You radically accept that, and you build on it. Music is really business. …You have to be using all of your senses at the same time, and you have to be dancing with the circumstances and evolving.”