Krause Fund Research Fall 2018 Industrials XPO Logistics, Inc. (NYSE: XPO) Recommendation: BUY November 9, 2018 Analysts Drew Rasmussen Andrew Straight Current Price $81.03 [email protected] [email protected] Target Price $91 - $97 Erik Miller Joseph Tomczuk [email protected] [email protected] XPO’s Future is Bright Company Overview • Revenue growth in both the transportation and logistics XPO Logistics, Inc. (NYSE: XPO) operates in the segment show major upside in the future: XPO’s revenue has transportation and logistics industry in the United States, major upside potential in the future, projecting to grow 10% in Europe and Asia. XPO is the fastest growing company in its 2018. They have put an immense amount of focus into growing industry. They operate about 63% of their business in the last mile services in North America as well as expanding last transportation segment and about 37% of business in the mile services into Europe. They are also the number one logistics segment. XPO has put an immense amount of provider of large truckload services in Europe. The Logistics focus on increasing their share in the logistics segment of segment is looking to have major growth as they take their business model. XPO’s total revenues grew 5% in advantage of increasing world-wide e-commerce growth, and a fiscal year 2017 to $15.543 billion, and pre-tax income grew focus on being a one stop shop for their customers providing 144% to $260 million in 2017. both transportation and logistical services. • Focus on technology and innovation gives XPO a Stock Performance Highlights competitive advantage over competition: One of XPO’s top 52 week High $116.27 corporate strategies is to be the leader in their industry of 52 week Low $71.36 technology development and innovation. They plan to invest Beta Value 1.826 over $450 million towards technology in 2018. Robots and Average Daily Volume 1.36 m artificial intelligence have already become a part of everyday operations. Share Highlights • Brand Image and market position creates major upside Market Capitalization $9.96 b potential: XPO is among the top transportation and logistics Shares Outstanding 114.9 m providers in North America and Europe. In a tightening worker Book Value per share $32.63 supply environment, they have still received over 80,000 EPS (FY 2017) $0.87 monthly job applications this year. P/E Ratio 21.40 • Abundance of FCF creates potential for M&A activity as Preferred Dividend Yield 4.00% well as support in a recession: XPO is on track to have a cumulative FCF of $1 billion from 2017-2018. This allows for a Company Performance Highlights cushion in the case of a recession as well as potential for future ROA 2.80% M&A activity. ROE 11.20% • E-commerce growth allows for tremendous logistics Sales $15.54 b upside: E-commerce customers account for XPO’s largest portion of revenue. E-commerce is projected to grow at a CAGR Financial Ratios of 9.6% from 2018 – 2022. Current Ratio 1.20 One Year Stock Performance Debt to Equity 1.13 1 with the unemployment rate approaching record lows of Economic Outlook 3.7%, paired with an increasing labor force participation rate. It is no surprise that economic growth and Real Gross Domestic Product (GDP) development is a pillar of the current Trump administration policy. Over 2 million jobs were created in 2017 alone, and Real gross domestic product (GDP) is an inflation-adjusted the implementation of the Tax Cuts and Jobs Act of 2017 reinforce commitment to a continuous improvement of the measure that reflects the value of all goods and services U.S economy. We project that trade uncertainties and produced by an economy in a given year. Real GDP is widely inconsistencies within the market will fade over the long run. recognized as a leading indicator of economy growth. Unlike Long term growth will be a byproduct of the foundation built nominal GDP, real GDP accounts for fluctuations in price over the last few years and optimistic workforce that’s level and delivers a more precise figure of economic growth. reflected through the increasing labor force participation rate and record high consumer confidence levels. This strong growth bodes well for the Industrials sector overall because the Industrial production output has a positive correlation with the market performance. Interest Rates Interest rates are one of the most important aspects of an economy, influencing many decisions including borrowing and expected return on investments1. Interest rates are Source: Bureau of Economic Analysis influential in an economy to promote or cool down growth because of its direct impact on the cost of borrowing. The Strong GDP growth over the past year and a half has spurred U.S has experienced a record low interest rate environment new investment opportunities, increased consumer the previous 10 years due to an attempt to promote growth confidence, and dropped unemployment to record lows and expansion within the economy post-great recession14. In within the U.S economy. Even with equity markets recently 2018 alone, the Federal Funds Rate (FFR) increased three experiencing some unsettling volatility, fundamentals of the times to a current benchmark of 2-2.25%, with current economy remain strong with GDP growth north of 4% and signals pointing towards a fourth increase of 25 basis points 3% in Q2 & Q3 2018 respectively. The Industrials sector is before year end14. Changes in the FFR have a primarily direct very cyclical and especially sensitive to changes in the overall relationship with the 10 year Treasury note, which is market. The Industrial Production Index (IPI) measures the commonly used as the risk-free-rate for borrowing when real production output of manufacturing, mining, and analyzing different investment opportunities. utilities; demonstrating the overall health of the Industrials sector. Historically, growth in the IPI has had a positive correlation with real GDP growth. Source: St. Louis Federal Reserve Source: St. Louis Federal Reserve Due to the nature of business and material & equipment utilized within the Industrials Sector, companies rely heavily Real Gross Domestic Product Outlook on borrowing to fund much of their capital expenditures. The Fed has been relatively transparent about their plan of We anticipate Real GDP to increase by 3.0% and 3.25% in the gradually increasing rates until a neutral level—which Fed short and long-run, respectively. This is a reflection of the Chair Jerome Powell has mentioned are not near a neutral strong fundamental drivers in the market in addition to level, yet. While President Trump has been vocal about his recent external factors mitigating potential risk looking personal negative view on the potential for continued future forward. Current employment data supports our hypothesis 2 rate hikes, the Fed does not show any sign of altering their future growth projections. We believe that because stance going forward. consumers have weathered equity market volatility and political uncertainty the past two years with very little We project that rates will increase once more in 2018, and impact on consumer confidence, this outlook remains three times in 2019 because of continued strong strong. fundamentals and growth in the economy. While some may interpret interest rates increasing as a negative, we Tax Considerations recognize that it is necessary to offset potential inflation and other adverse effects of a thriving economy. We believe that In December of 2017, the Tax Cuts and Job Acts (TJCA) was markets have already included these future rate hikes into signed into law and has become the largest tax overhaul valuation, and that future overall capital expenditures will since 1986. The TCJA has introduced a number of changes to not decrease dramatically. the way that business are taxed. In one of the largest changes, the TCJA will reduce the business sector’s tax Consumer Confidence liability by the changing of business tax rates and the business tax base. Consumer confidence is another key indicator of the state of the economy because it is based on consumers’ thoughts on the current and future state of the economy. Industrial production has historically been highly correlated with consumer confidence. When people feel better about the economy, the more they feel they can spend on industrial goods and products. There are two ways of analyzing the consumer confidence level: The Consumer Confidence Index (CCI) and the Michigan Consumer Sentiment Index (MSCI). The Consumer Confidence Index is conducted by surveying 5,000 Source: Tax Foundation, Taxes and Growth Model, Nov 2017 households by the Conference Board. The CCI is based on benchmark score of 100 from the year 1985. As of October In the short run, GDP is projected to grow roughly 0.44% 2018, the CCI stands at 137.9, the highest score of all time2. above baseline projections as firms utilize the immediate The Michigan Consumer Sentiment Index is conducted by expensing of short-lived assets and lower tax rates1. This the University of Michigan through a survey of 500 looks to promote capital expenditures, which promotes households, a very similar process to the CCI. The MSCI economic growth. This accelerated initial growth will likely reflects roughly the same data as the CCI and accounts for reduce in a few years due to the temporary nature of many outliers by removing the most and least favorable replies. of the provisions. However, while economic growth is The graph below depicts the MSCI, and similarly to the CCI, borrowed from the future, the plan still expects economic the index is near all-time highs. growth to surge over the long-run. Beyond the first decade, the plan aims to broaden both income and payroll tax base to make up for revenue shortfall and cover the cost of the plan.