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

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Hi. Welcome, everybody. Good morning. My name is Allison Poliniak. I'm the senior analyst here at Wells Fargo, following the industrial technology and transport sector. We're excited to introduce XPO as our next presenter at the Wells Fargo Industrial Conference. And with us today from XPO is the Chief Strategy Officer, Matt Fassler. But before we go into Q&A, I just want to remind folks, if you do have a question for Matt, please e-mail me at [email protected], and we'll try to get the questions to Matt in attendee fashion.

But Matt, turning to you. It's certainly an interesting point in the XPO evolution, announcing the spin of the logistics business into XPO. Maybe kind of talk -- walk us through the thought process behind that split or the spin. Why the spin over a sale? Just any color to help investors better understand the decision behind that.

Of course, first of all, Allison, thanks so much for having me today. I'm happy to represent the company at your conference. As it relates to the spin, the -- one of the primary goals is to create significant shareholder value. And we think that we have the opportunity to help perpetuate that as we execute on the transaction. Post the split, shareholders would own stock in 2 industry-leading pure plays. And we think that in comping against pure plays, the [ acquisition ] market would be more able to assign the appropriate evaluation. And again, that's probably something that was not discounted in the stock. Now beyond that, there are a number of other strategic rationale for pursuing the spin that we think can enhance our operational outlook and our financial outlook going forward. Each management team will be focused uniquely on those strategic priorities and business operations that relates to the business spin on [ the NewCo ], whether it's the transportation business through XPORemainCo, or the logistics business through GXO. And there'll be a simplified business model associated with that. Each management team will be able to tailor a number of key decisions to the mix of business and the profile of the business that it runs. That could relate to capital structure, capital allocation, it could be capital allocation to acquisitions, capital allocation to operational CapEx as well. Each team is going to be working on developing proprietary technology, notably software, that most precisely addresses its need. And finally, each company, with its own equity currency, can use that currency to attract talent. After all, each of us, I think, ultimately likes to have the most control over our financial destiny. And working with a smaller, more focused company, each member of the team can help drive the performance more directly of that entity and also to use that equity currency for strategic transactions. So that's the long list of reasons that we thought the spin was a compelling way to both optimize value and improve our strategic position.

Now I want to start going into each of the businesses. But maybe first, let's start with LTL and the transport business. Obviously, a very strong consumer demand, consumer goods-related demand over the past year. How do you feel that's going to evolve sort of in this reopening phase? Does that strength continue here, at least through the year? Just any kind of view on that.

You wanted to focus the comment, Allison, on the consumer for LTL or, really, the broader look at the impact of the consumer on the business?

Well, I would say, less any logistics, so I think that's its own dynamics right now, but more in the transport side. When you look at the transport portfolio, what about -- how is that consumer-related goods aided that business? And how should we look at that over the next, say, 12 to 18 months going forward in terms of that demand?

Of course. I think that the outlook for consumer demand remain very strong. I think that's the case for a couple of reasons. Number one, the economy, broadly speaking, as we covered nicely, the amount of disposable income is obviously continuing to grow. That's both through the private sector and also, obviously, through some public sector subsidies that have really helped bridge the consumer through what would have been, and has been proven to be, an extraordinarily difficult time. A secondary consideration is that there's still a lot of pent-up demand and certainly pent-up fulfillment opportunities in some of the bigger-ticket areas. And you had a housing wave as well. And that housing wave tends to drive purchases of big-ticket and housing-related durable goods. So for all of those reasons, the consumer outlook remains strong. The consumer sector is the largest driver of business for XPO. That's a bit more true on the logistics side than it is on the transportation side, yet large and linked to transportation, more true in the brokerage piece of the business among brokerage customers than among LTL customers. All that being said, we're benefiting collectively in both pieces of the company from the strength in consumer. As it relates to LTL, the biggest piece of our LTL business and the majority of our LTL business is industrial. And the consumer contribution to that business is smaller, but it is growing. In fact, and we made a comment to this effect on our call earlier in the week, consumer sectors have been the strongest contributors to the acceleration that we've noted in North American LTL. Structurally, the growth of e-commerce means a higher number of smaller shipments delivered more closely to the consumer. So LTL, we think, is structurally growing -- or rather, consumer is structurally growing within LTL. It's just not yet moving -- that share shift into LTL is not yet moving the needle as much as the underlying trend in consumer and what is [ committed ] the entire market. And importantly, the rather nascent but emerging industrial recovery in LTL.

Yes. And that's a great lead-in for me in terms of industrial. I think we heard yesterday, I mean, taking a step back over earnings, right, I think there was some disappointment and a little bit more conservatism in industrial recovery in the second half. And based on conversations that we've heard yesterday, the industrial side is [ still in a recovery ]. Capacity is tight. How is XPO focused on balancing that industrial recovery with what the strength of the consumer demand still is? How are you guys viewing that strategically?

I mean we're not terribly distorting when it comes to the business that comes across the chasm. If it's consumer business, that's great. If it's industrial business, that's great. Obviously, we have the most industrial -- if you look around the company, we have a good deal of industrial exposure in LTL. One of the reasons that business accelerated meaningfully in March was the recovery that we saw in industrial. And that is continuing. Then to your point, it's much earlier in its recovery than the consumer recovery. If you look at the actual industrial production numbers as opposed to the ISM, they're also earlier in their recovery. And they're not as far up into the right as consumer is. So it is still early days. And one of the reasons we're encouraged about the outlook for the business is how far we have to run in that industrial arena.

That's great. And just staying with LTL for a minute. Is there a way to think about -- and this might be something you guys talked about when the formal split happens or spin happens. What's the long-term growth algorithm that we should be thinking about for LTL in terms of XPO's ability to gain share in the market? Is there sort of a normalized growth sort of algorithm you think about longer term for that business?

Our goal in LTL, as it is elsewhere in the business, is to make money and more money. And that is really represented by EBITDA dollars. And there are obviously lots of different paths one can take to maximizing EBITDA dollars. In LTL, while we have believed for some time, and we continue to believe, that our biggest opportunity is [ new ]. It's a very healthy sector in terms of pricing momentum as capacity is tight. We are a market leader with a high-quality product delivered on a national business. There's a number of companies that are in similar position, so there's a [ finite ] number of companies. And that bodes well for depressing outlook in the space. Our -- the opportunity we're most focused on is the company's specific opportunity to improve our understanding of price elasticity and our ability to extract more yield from that. We bid on much more business than we win. We frankly lose more bids than we win, which is the way that the math works, and that's fine. We have to learn from every bid. We have to learn from the bids that we lose -- that were losing, as it turns out. We need to learn from the business that we're fortunate to lose. We need to learn from the business we're happy to win and learn from the business that we won. And this happens sometimes, that probably we would have been better off without. No one person or no one chain can digest that information and systematize it. It needs to be captured in grand fashion online and needs to be deployed to help shape pricing algorithms that help influence the way we bid going forward. Based on what we learned about characteristics at play, regional dynamics, customer dynamics, industry and vertical dynamics, that is really where the biggest opportunity for us is to drive yield above and beyond what the market is able and willing to give us in the ordinary course. And that's the biggest opportunity for P&L in LTL. Beyond that, we have big productivity opportunities. Optimizing routes is a huge opportunity for us. One of our biggest expenses in LTL is line haul, and we have -- we're on, as you know, millions of miles, and we have a big opportunity to optimize routing line haul. A second, albeit smaller, expense is in pickup and delivery. We have big opportunities to optimize our spend in that area. These are areas offering opportunity for continuous improvement. Market share is great, but we are -- we get much more flow-through on the dollar delivered by yield, and we have much more control over our own destiny as it relates to the cost management piece. So the progression to EBITDA growth is going to be driven more by yield and by productivity. Obviously, revenue growth is a piece of that, but we expect to continue to drive meaningful OR improvement. Over the last 5 years, we've driven about 1,000 basis points of improvement in adjusted OR, ex our real estate efforts. And we see more upside from our LTL operational initiatives to move the OR even more.

That's great. And actually -- keeping on that theme, we heard a lot about labor yesterday, right, in terms of -- I mean, everybody is aware of the driver shortages, but not only that, productivity of the workforce. And I would say, XPO has done a lot of work, kind of freed us, in a way, with your technology in terms of aiding that productivity. Could you maybe delve into some of that technology, kind of the productivity benefits that you're seeing within LTL, just in sort of the dock area? Just any thoughts around that in terms of how you're accelerating that now?

Sure. So we have -- one of our most innovative developments, most original innovations, I guess, I would say, in the company is our Smart workforce management platform. It's a software platform. It is used in labor planning and scheduling, kind of on an intermediate and short-term basis. But it's also used in real-time analytics to assess who is on the floor to get point in time, what the workflow is supposed to be, what it actually turns out to be. And it looks at the alignment of resources on the one hand, demand on the other hand, and gives managers on the floor the ability to optimize them in real time. It's that real-time management capability that is so differentiated. It does so with a very intuitive interface. If you're on one of the docks, you would see the screen, you would understand it. And it gives the dock operations supervisor in LTL, or by the way, we use this in supply chain as well, our managers in supply chain and contract logistics, the ability to modulate labor. There's a lot that you can learn from what happened yesterday, but it's not nearly as valuable as what you can learn for what's happening now. We have the ability to effectuate change in labor optimization in the moment. And that's really helped us manage what, to your point, is in fact a tight labor market.

That's great. And I want to turn now to logistics. Obviously, you guys just reported a fantastic quarter. Could you maybe walk through where we are in the life cycle of that logistics business? Is there still a lot of opportunity out there for the eventual spin here? Just any color around that.

I mean we're -- we have the second largest logistics business in the world, so we're certainly not new to this business. And many of our best customer relationships are customer relationships that have a decade or more of tenure. So we're not in the earliest days, but we are still, broadly speaking, in the early days. And there's really 4 interrelated reasons why. First of all, e-commerce penetration continues to grow. And I think that the capacity, the logistics capacity supporting e-commerce today is still trailing the amount of demand that is being satisfied. A lot of e-commerce demand is being satisfied inefficiently. So our customers, many of the retailers and brands out there, are still trying to find the most effective way to respond to the e-commerce opportunity that has emerged. It was emerging prior to the pandemic. That emergence was obviously accelerated by the pandemic, and we'll see that those who share shifts to e-commerce are going to withstand. Secondly, industrial automation in the form of warehouse robotics is still in its early, early stages. And that creates a whole opportunity of warehouse modernization. It creates a whole new financial model for the warehouse. That key is in its early innings. We have an early-mover advantage in that space, and that helps us bring value and efficiency to our customers. Third, there is near-shoring and on-shoring. We signed a new deal, our first deal, with [ ATA ]. There's an element of on-shoring for them. It's interesting, onshore, and was brought up a lot. Really early on in the pandemic, as China was the first country to really feel the hit. And then there were questions about, "Oh, my goodness. We over rely on overseas supply chains." Those questions and that team got more and more heated as the pandemic became much more severe globally. I think that, that theme is still very relevant. It's a bit more of a similar, I think, as it relates to the magic reports on the Street and such, but it's actually happening. And we're seeing these deals. And Malcolm Wilson, my colleague who's going to be the CEO of GXO, has spoken out all the activity he is seeing among European customers to onshore or near-shore their supply chains. And then finally, those 3 drivers, e-commerce, automation, near-shore, converge to drive incremental outsourcing of distribution and warehousing needs. And those factors, I think, create a very long runway for the outsourcing of -- and the growth of the logistics -- the outsourcing logistics, that is, and the growth of our contract logistics business. And we talked to -- certainly, we'll talk more about, if you like, a number of high-profile and large contracts that we signed that I think reinforce the vigor of that team today.

No, that's great. And that was one of my questions, too. I think you guys defined them as whales, right? You got a lot of significant contracts on this past quarter. It sounds like there's certainly more opportunity out there. How should investors think about how that flows through the financials, right? Is it something that builds into the second half? Or is it more sort of '22 kind of benefit you could have?

Whale is being a highly technical term, of course. We are -- they flow through over time. So some of these deals -- and it was a mix of renewals and new business. The renewals, to the extent that they cover contracts that would've been up for expiration, say, in '21, '22, then what you would have is continued. The new business typically ramps some of our -- does take some time, some of it ramps in '22. We spoke about new or renewed business that we underwrote in the first 4 months of the year, around $4 billion in total contract value. But that -- the new business does take some time to ramp. One of the realities of contract logistics and one of the elements that makes it such an interesting business so that there is a lot of consultation. There is a lot of collaborative engagement early on for us to understand the customers' needs us for us to map up, map out, that is, and then ultimately stand up the solution. We run, to a high degree of difficulty contracts, with the oft to a claim. One of the ways in which we're differentiated is that we can get very close to these Fortune 100 -- Fortune 200 companies, understand their needs. Because we worked with other ones before, there's very little that we see -- that we haven't seen previously, which means that we can address their needs. They're highly complex needs quickly and implement advanced solutions at scale with it, obviously, responsibly, but we can do it rather quickly. All that being said, the proposal and implementation processes take months and sometimes many months. So some of the stuff we spoke about, some of the new business that we discussed over the past week, will ramp this year, some of it we're going to have next year. But don't forget, there's other new business that we signed in 2021 that will ramp-up in 2022. So -- but we have very good visibility for the pipeline and the implementation of new business won, or GXO.

That's great. And I want to turn and kind of get back to technology. They've been yesterday with ESG. And from the transport side, battery-powered trucks, autonomous driving, is this sort of a realistic option? How are you sort of attacking the ESG component of the growth going forward?

I mean ESG, obviously, is extremely broad thematically. One element that's really important for transportation is EVs, another one that one could look at, if you recall it, ESG is autonomous. I mean it's more about just innovation, if you're loving per se. We're really interested in both of them. We're focused on implementing them as they get ready for scaled commercial use. We're really looking forward to EV engineering becoming competitive with diesel; on line haul, transportation in terms of range and in terms of cost. We have a number of EV pilots that were engaged then. I think it was about a week ago that we announced the collaboration with Daimler Trucks North America. You obviously had a good truck manufacturer to test their battery electric commercial trucks under real-life operating conditions on the West Coast of the U.S. Our drivers will use tractors from their innovation framework, in our innovation area. It will be a 9-month pilot program that will be in the area, and we'll use the data, and they will use the data, and naming some that pilot to help inform their final design of battery electric trucks prior to the full-service reduction. So you can see that our most important -- some of our most important vendors, again, but obviously, the very high-quality vendor are very much in the developmental stages here. And what's really important for us is to stay close to our members, close to the technology, understand when the economics become viable, realistic and compelling. And then we'll be there, and we will have been in the form of stages with those vendors. As it relates to autonomous, we don't have any now. There aren't many in the marketplace. We're interested or open-minded, neither the technology nor the regulatory dynamics or the RF for this to be implemented currently. But of course, as an indicator we'll be -- we'll be watching closely.

Great. And one question we often get is, obviously, XPO has been well down the path of that $700 million to $1 billion profit improvement. How does the spin alter that, if anything? Does it start to accelerate some of those benefits?

So to your point, we have a list of profit initiatives, which we've been discussing, both internally and with the investment community. To name some of them, and we talked about some of the analysis over the course of this conversation with XPO Smart, which impacts both LTL and contract logistics. There's our pricing algorithms I spoke about within LTL. They're also relevant in brokerage. There's actually a connect that we haven't spoken about at all, which is our digital freight marketplace in brokerage. There's our supply chain automation and networks, line haul optimization in LTL as well as P&D optimization in LTL. These are some of our larger opportunities. I named some of the more operational ones, in addition to some of the more generic ones focused around areas like our G&A and procurement optimization. We are going to divide them up, if you will. And by the way, a list of key initiatives should never be a static list. It should be a dynamic list. And there are some areas within GXO and some areas within transportation, XPO, RemainCo, that will likely rise to the surface of their new or emerging, where they have the impact to be meaningful -- more meaningful to a smaller enterprise than they would have been to a larger enterprise. Clearly, we have a path to operating leverage in both XPO and GXO. And these initiatives and others are really going to be drivers of that.

Great. And I certainly can't let you go without talking about balance sheet, M&A. I know I told your team this morning earlier, we're impatiently waiting for that Form 10. So maybe, on a high level, I know you guys had kind of touched on sort of how you're looking at leverage and such coming out of the spin. Talk to that, is M&A still very important for you guys going forward in terms of building both sides of the business? I know we touched a little bit on the opening question. But any color there that you can help with?

As it relates to the balance sheet, first of all, we are going to stand up GXO as an investment-grade credit on day 1, and we're engaging with the rating agencies to work with them on what exactly that will entail. And when we have finality on that, we'll share with the investment community. We're also committed to our past strategy for XPO foreign income, and we will continue to pursue that path until we get there. You asked about M&A. This company was built on M&A, though more recently has been built on organic growth and operational enhancement. It's also been built from day 1 based on the notion of technology innovation, and that remains very central for us. M&A absolutely remains part of our playbook. We're going to continue to assess opportunities. M&A is one of those things that we talked about after the fact, less so before we handed out targets and such, but we have not closed our eyes to the opportunities out there. Brad, obviously, has an enormous amount of M&A experience and M&A success over the course of his career at every public company that he has started and run. And that is absolutely the case here, both for XPO and for GXO. And we're going to pursue it in a way that is harmonious with our target of investment-grade credit rating for both sides of the business.

Great. Perfect. And we did get a question in final mile, any color there? Why is that an interesting market for XPO?

It's a really interesting market. First of all, they had a killer quarter. We had a killer quarter, I should say, in final mile. Our revenue was up 22%. The big and bulky goods area is thriving. I spoke earlier when we were talking about the consumer about the housing surge and about not only the business that comes simultaneously with that, but also the aftermath of that. And that's a very powerful tailwind for those goods. We are the largest last mile logistics provider of last mile for heavy goods. We are the largest provider to many of the most important customers in that space. And the quality of our service is extremely high as well. Our claims experience is exceptional, meaning that we're able to deliver in a really seamless fashion to consumers on the [ upper limit ] of our customers. It's a hard business to execute. We have advantages of the scale. We have advantage of the technology more and more. As a customer, we're solving -- as a consumer, that is, we're solving for your pain point of where is the truck, where is the guy or the woman who's delivering this stuff. I don't want to wait at home. What's the real story? And we're able to provide that real store for you, which makes it a much more seamless experience for you as a consumer. That quality reverberates for our customer as the retailer or brand who hires us to deliver those goods. And it's interesting because it's a growing area. It's an area that is supported by e-commerce, and it's an area that plays to our technology strengths, too.

And another question came in on e-commerce. Returns management, how important is that as a growth vertical for you guys in terms of the logistics business?

It's important and interesting. It's an area where we've established real expertise, and we have some real capstone contracts as the key reverse logistics provider from some of the brands you would absolutely want to have in your court if you're in this business. With e-commerce comes returns. And by the way, the work we do in reverse is not limited through e-commerce. Store-based returns for retailers, also need to get processed. But e-commerce, I think, is generating more frequent returns, I'm sure, around your household as and around my household. You buy things, you might buy more than we actually intend to keep, and led by a few sizes of the same thing. So by definition, we're going to be giving on that. We're not trying to be blissful. We're trying to be efficient. And our -- the retailers who we are from -- an enabler and break down the formula that works for everybody. All that said, return to inventory has a lot of value. And it's still appreciated over time. Return apparel is not like fine wine. We have to process it quickly. You want to divert it to the means where it's going to be recirculated, remarketed or disclosed that with the highest potential value. There's much, much trapped value in the reverse logistics supply chain. And working with our customers, not only on the [ facilitated ], but also on the planning and on the mapping out of the processes for this routing, and ultimately how the goods are diverted after the fact. We had a tremendous amount of value. When I talk about high degree of difficulty and with large customers as a general theme as to where we excel, reverse logistics that is [ core to GXO ]. We think there are many more companies who have yet to really optimize their longer-term processes, [ and yes, where we help them ].

Great. It sounds like we're coming to the end of our time. Any closing remarks that you'd like to make, to make investors [ click ]?

We're excited. We had a good quarter. We're excited for the outlook for the year. We raised our guidance as evidence of that. And Allison, I'm really happy to spend this time with you, and thanks for the great questions that you engaged.

Great. Thanks so much. We'll talk to you soon.