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Morningstar | XPO Tempers 2019 EBITDA Growth Expectations; Sentiment Swings Negative

Global transportation and logistics provider XPO Logistics’ issued a brief 8-K indicating management expects adjusted EBITDA growth of 12%-15% in 2019, down from its previous “base case” of 15%-18% discussed on its third-quarter conference call in November. This compares with consensus that’s been baking in an approximate 15%-16% EBITDA increase for next year. The firm also expects free cash flow of $650 million in 2019, which compares with prior consensus of more than $800 million. Management did not specify the reasoning behind its adjustment other than to say it disclosed this information in a meeting with a “group of investors in the ordinary course of its investor relations activities.” The guidance revision, coupled with negative commentary in a recent short-sell report from a third party hedge fund, sparked heavy selling pressure on Dec. 13.

As a result of the updated guidance, we modestly lowered our 2019 adjusted EBITDA forecast to $1.75 billion (from $1.78 billion), which reflects 10.5% growth versus 12% previously. This is a relatively minor tweak to our estimates since we’ve already been assuming currently-robust pricing conditions for truckers and freight brokers moderate next year, tempering opportunities for margin expansion. That said, the revised free cash flow guidance was somewhat surprising, and suggests to us that XPO’s working capital requirements are on the rise; though the source of that is unclear. Nonetheless, we expect to take our 2019 free cash flow estimate down by more than $150 million, to $650 million, due mostly to boosting our working capital assumptions for the years ahead, and to a lesser degree our lower EBITDA forecast. Overall, we expect to reduce our $66 fair value slightly, by 3%-5%.

Following more than a year in what we considered to be highly overvalued territory, the shares are now modestly undervalued as of market close on Dec. 13.

In our view, XPO’s stock price was previously baking in overly optimistic long-term growth assumptions (for much of the past two years) due in large part to an exceptionally favorable pricing backdrop--a common theme among transportation stocks for much of 2017 and 2018. That said, as it’s become more obvious that demand and pricing gains will slow meaningfully in 2019 (a trend we’ve long been baking into our fair value estimates), market valuations for trucking and logistics stocks have been correcting. Uncertainty is high because of XPO’s previous roll-up strategy and unusual asset-light/asset-heavy operating model, but following the sell-off on Dec. 13, XPO is looking modestly undervalued to us.