XPO, Inc. (XPO) Earnings Call Transcript & Summary

Great. Good afternoon, everyone, and welcome back to the Morgan Stanley Life After COVID Conference, the e-commerce track as we have it today. For those who don't know me, I'm Ravi Shanker, the firm's freight, transportation and airlines analyst. And we're very pleased to have with us today XPO Logistics and Erik Caldwell and Matt Fassler. Gentlemen, thanks so much for joining us.

Happy to be here.

Great. So before I kick off, I'll have to note that please note that this webcast is for Morgan Stanley's clients and appropriate Morgan Stanley employees only. This webcast is not for members of the press. If you are a member of the press, please disconnect and reach out separately. For important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. And for the audience, if you have any questions to the management team, please submit them via our webcast browser, and I can pass them on to the management team. And with that, again, as I said, very happy to have with us Erik Caldwell, who's the President of Last Mile Logistics for XPO. Erik has a responsibility for XPO's last mile operations in North America. Mr. Caldwell has more than 15 years of leadership experience with complex supply chain operations in the consumer and industrial sectors. He joined XPO from Hudson's Bay Company, initially serving as Chief Operating Officer for XPO supply chain business unit in the Americas and Asia Pacific. His roles prior to XPO includes Senior Vice President, Supply Chain and Digital Operations for Hudson's Bay Company; Senior Vice President of Global Revenue Operations for Luxottica; the Director of Retail Solutions for DHL, where he also served as a Regional Director of DHL's last mile operations. And additionally, Mr. Caldwell also consulted on global operations for McKinsey & Company. He holds a Master of Engineering degree in supply chain management from MIT. Erik, welcome and thanks for joining us.

Thank you.

And we also have Mr. Matt Fassler, the Chief Strategy Officer. Mr. Fassler is responsible for the company's strategy, capital structure and analysis of growth opportunities. Prior to XPO, doing more than 20 years with Goldman Sachs. He covered many of the world's most prominent brands, including Walmart, Target, Costco, Home Depot, Best Buy and AutoZone. He additionally served as Managing Director and business unit leader for more than 10 years with responsibility for the broader consumer sector. Mr. Fassler has been recognized 16 times in the Institutional Investor All-America Research Team ranking, and he holds a degree in University from Yale University. Matt, thanks for joining as well.

Thanks again, folks.

So Matt, maybe, again, you guys are -- XPO Logistics is a giant in the world of freight transportation and logistics. But given that we have more of a broader, more generalist audience for this event, maybe you can kick off with kind of telling us more about XPO, its role in the freight transportation and logistics world and the specific role that you guys play in e-commerce.

Of course. And Ravi, thanks again for having us. So do many more conferences with you, but hopefully no more with any COVID [ in that time ] for obvious reasons. And so we are a leader in the fastest-growing areas of transportation and logistics. We generated about $17 million in revenue in 2019, about 60% of that in North America and 40% in Europe. The logistics industry, as you all know, is getting more complex and operators with scale and technology and industry efficacy for that combination have unique opportunity to capture market share and to build incremental profit opportunity. Our own share of the global logistics market, really adjusted in the regions that we operate within, is relatively small, really less than 2%, which creates a very strong market share and revenue opportunity. There are 2 trends driving the industry opportunity today, 2 high-level [indiscernible]. The first is increased customer demand for third-party supply chain management and that has continued to grow and probably accelerate with the pandemic with brought supply chain visibility to the top of mind for senior management and for many of our customers. Also, there's the increased deployment of tech and data management across supply chains, which is helping companies to price more efficiently and to better manage their fleets and their labor. Now deep diving into e-comm. E-commerce is one of our largest verticals, and it is our fastest-growing vertical. We have exposure throughout our company, but it's focused in 2 lines of business. One is Erik's area of operation currently, our last mile for heavy goods. We are the largest provider of last mile services for heavy goods in the U.S., about 50% larger than our next largest competitor. The second area is contract logistics. We are #2 in the U.S. in contracted logistics, we're #2 in Europe, and we're #2 globally. We operate about 200 million square feet of warehouse space and we're a top 5 industrial tenant in North America. As it relates to e-commerce, in particular, we are a leader in both forward and reverse logistics. We operate the leading freight fulfillment platform in Europe. We deploy automation in the warehouse in the service of our customers and more and more of it each year. And finally, we operate XPO Direct. This is our shared service distribution network. It's expressly designed for e-commerce customers. Return to profit -- for XPO Direct, returning to profit for XPO Direct in 2020, which is only its second full year of operations.

Great. Thanks. That was a great summary and probably no better time to be in the e-commerce space than right now, given everything you've seen this year. I think one of the more kind of shocking or explicit changes as a result of the pandemic was the volume surge that you've seen this year on the e-commerce side. Maybe you can take us through your understanding of how much of that is permanent versus transitory? Meaning, how much of that will stay online e-commerce versus going back in the store? Also, what does this mean for growth in the coming years? If we have pulled forward 3 years of e-commerce penetration, do you think e-commerce continues to grow as the [ shredded ] rate it has been in the last few years? Or does that more [indiscernible] in the coming years?

You're right. That has been an extraordinary year for e-commerce. I think we've all lived it. Certainly, Erik and I and our colleagues professionally and all of us personally as well. As to the sustainability of growth, in a sense, I want to put it right back to you. I took a look at the Morgan Stanley e-commerce model, at Brian's model for industry growth. And he expects U.S. e-commerce sales to still grow 8% in 2021, despite, if you will, a very tough comparison. That's not surprising to us. Consumers' habits are changing. Brick-and-mortar capacity is exiting the marketplace. I think both of those dynamics accelerated and in a lasting way here in 2020 with the pandemic. But we still think we can grow at an outsized pace longer term. E-commerce was a 15% growth channel, year in, year out for many, many years. [ If it took below ] that next year, it would still grow faster in overall consumption, we think it can return and will return to double-digit growth in ensuing years. If you look deeper into the composition of e-commerce growth, by the way, as you look into next year to 2021, our sense is that growth for our customers and for the verticals in which we play most in e-commerce, will be stronger than overall market growth. I'm talking about segment cargo goods and apparel. Some areas that had outsized growth this year like online grocery, for example, we do less in online grocery, very little of online grocery. We do a whole lot in food and beverage, but less on online grocery per se. Why hasn't it moved higher yet as a percent of the overall mix? I think consumer trends move gradually. There's a tremendous amount of [indiscernible] less food and purchase and [ demand ] food. Tremendous amount in value channels, tremendous amount where the economics of direct distribution are not yet superior to the store. But we think, overall, the trends that we just discussed, brick-and-mortar capacity coming out, consumer habits changing suggest an awfully long runway, it's an awfully runway for e-commerce. And we're going to participate in that as well.

Got it. So that was a look at e-commerce from the demand side. Kind of looking at e-commerce on the supply side, how does the current warehousing capacity able to support this volume? How much growth do you think we need to see there? And again, is this similar warehousing capacity to what we've seen in the last few years? Or is there something different about it compared to the way either in terms of location or the type of warehousing capability you guys have been adding over the past several years.

So Ravi, it's Erik. It's the most exciting time to be a professional supply chain, right? This invisible industry where if you did everything perfectly, no one noticed you is the focal point of the entire country. And we're seeing such a strong growth in warehouse space. Talking to real estate brokers, there were 70 million square feet of space added alone this year in Q1, Q2, Q3 for e-commerce. If you split out Q2, 46 million square feet was added around e commerce. And as a general guideline, we think for every $1 billion of online sales translates to about an additional 1 million square feet of warehouse space that's required to support that. As we're seeing this really strong growth, if you compare the ratio of industrial space that went to e-commerce last year, it was about 35% and this year it's over half. So the answer is yes. Very strong growth. And if anything, we're seeing supply chains and customers really chasing this trend at this point to get additional space going into this peak and then preparing for next year. I think these trends have legs, and we're going to continue to see consumers shop more online. I don't see that changing. And that's going to drive this warehouse space. We as a company added $61 million -- excuse me, $61 billion -- I'm sorry, I missed it, [indiscernible] again. $61 billion of e-commerce sales were added year-over-year in the market as a whole. And so we're seeing the benefit of that as a company as a real strong macro tailwind with the secular growth in that space. The other part is we're seeing a change. Our XPO Direct network allowed companies to get into a regional model. Historically, you can get away with a central DC supporting the country with catalog sales and retail sales. We went by coastal and we're seeing a lot of activity on the West Coast, and we're seeing a lot more companies get into the regional model. Our XPO Direct network allows companies to integrate directly to that and not have to get the footprint and share the benefit of consolidation with other customers in that. The other part is a lot of companies such as Connected Fitness, [ Mattresses in a Box ], these new e-comm direct-to-consumer offerings need a national network, and they need to forward stock inventory in market because they're very sensitive to service. And they also need to consolidate transportation into the metro market. So our WMx cloud-based warehouse solution supports this. Our XPO Connect technology gives us complete visibility around this. And the other part, it gives the customers the ability to understand what inventory to position in those metro markets, in particular, around last mile because it's difficult to move product from market to market. And so this is offerings that we're providing to the market that there's a great need for that. In fact, we built 88 last mile hubs across the U.S. and Canada, and we are within 90% -- excuse me, 125 miles of 90% of the U.S. population. And so we're giving customers that coverage for the last mile delivery and the ability to forward stock in our locations and XPO Direct to give them regional coverage for unallocated warehousing space. So I think these are real big secular trends. As I said, $61 billion of expansion in the e-commerce market is going to be a long-term tailwind for the logistics industry. I don't see that changing anytime soon, Ravi.

Got it. That's great color. And also a great segue to my next question. But you touched on the service needs and kind of being within 125 miles of 90% of the U.S. population. I think one of the big trends coming into this year was the real ramp-up in service levels for e-commerce delivery. Obviously, we went from 2-day delivery to 1-day delivery. We're in the process of making that transition as an industry. That's sort of going to hit a wall this year, obviously, with the COVID-related disruptions. And with the pandemic, I mean, service standards have dropped precipitously. They have come back since then. I mean today, if I place an order that's supposed to be delivered in 2 days, but it takes 5, in April, I would have said that's fine. Now I think I should be upset about it. I'm not sure. So again, how much of this do you think is a permanent shift? Do you think with the pandemic, customers have kind of permanently made the shift away from saying, "Hey, I need my box in a day whether I want it or not," to kind of maybe relaxing a little bit on that and kind of maybe going in different direction in terms of the variety of SKUs, they will probably rather order online.

So we're seeing the increase of agility in supply chains to meet the needs and have product available. Supply chains were strained during COVID. And we're seeing that even going into the peak period, especially in the large ticket items. And we do our own internal surveys, and we saw a 9% drop in the strongly impacted importance of free shipping. And we're seeing other categories take more importance there about reliability and accessibility for that product. So I think, Ravi, you're seeing that shift where that's become more important, less than 1 day less than free shipping, it's the availability of goods and the reliability of the goods. The other part is we did see parcel and post, probably more strained in that space with the volume increase, and it's harder to flex their network. And we saw delays in now. We also saw large companies increasing parcel surcharges and premiums on that along with that tightness in capacity. The other part is, we're really proud we saw peak level -- higher than peak level volumes this summer in the last mile delivery space as compared to last year's peak. Matt, on the earnings call, talked about an 11% increase in revenue while increasing our operating performance substantially. And then the final part of that trifecta is we saw our voice of the customer and our online impressions of our service improve by 200 to 300 basis points in that same time frame. And so I think you have to do all these well. You have to handle large volumes. You have to be able to scale up and scale back down to be nimble with your technology. And you have to really focus on the consumer and maintain that service level, especially in times of pandemic with uncertainty because the consumer, especially in a large good, it's an emotional, expensive product that you're very tied to that happens with the delivery in your own home. You have to remain focused on that and provide that continuity and that comfort for the customers during that deliver.

Got it. Maybe shifting gears a little bit and coming closer to your direct wheelhouse, which is last mile logistics. Obviously, kind of an area where XPO really specializes. And as Matt said at the top, is delivery of heavy goods, like appliances and exercise equipment and that sort of thing. That has been, I think, probably the biggest winner of 2020 if there has been any winner in 2020. But again, that was a space that was already growing very quickly. It has accelerated even more this year. What has surprised you so far about the growth of heavy goods last mile delivery this year? And where do you think that market goes from here?

So Ravi, I'll start, and I'll just take a moment to reinforce your comment on the momentum in that sector. I'm going to throw Erik a little bit of sunshine here, Erik and his team. So you mentioned one of these numbers. But if you look at the XPO Last Mile business in North America, in the third quarter, our revenue was up 11%. Our net revenue or gross margin, kind of interchangeable phrases, up 15%. This was the seventh consecutive quarter in which we achieved expansion in last mile net revenue margin rate. So it's a business that accelerated, grew at a rapid rate and has grown more profitable. So the good news for us is that has persisted. That trend is often limited to the pandemic. But certainly, to your point, it's a business that saw our customers' needs and consumers' needs arise during the pandemic. And Erik, I think, will give you just a bit more color here.

Thanks, Matt. And so we've walked off of these incredibly high industry standards for service and improved those. We've improved the revenue. We've improved our operation ratio. And what we're seeing from a macro trend in there, not just to our performance. But in 2013, the heavy goods delivery market was around a $8 billion market. And this year, it's going to end up somewhere around $13 billion. And many companies, on their programs, who were online have actually pulled forward a couple of years what they plan to do online, especially around the heavy goods. And what we're forecasting, what the market is showing that this market will grow to somewhere between $16 billion and $18 billion by the end of 2023. So the market is growing as a whole. Within that market, there's some interesting trends. In 2013, 22% of orders for heavy goods were ordered online. This year, it's somewhere between 33% and 35%. By the end of 2023, it's going to be greater than 38% of all heavy good orders are going to be placed online. Again, talk about secular macro tailwind. These online orders are driving more outsourced transportation. They're adding a lot more complexity that requires providers of scale with national coverage, with amazing service and really capable technology to deliver these. And so that's what we're seeing in this space, and we don't see it slowing down at all. It's a good time to be in supply chain, and it's a really great time to be in last mile.