RXO looked to be avoiding the worst of the freight market, but no more
When RXO came out with its first-quarter earnings for 2023, its performance was clearly superior to those of its brokerage peers, and it looked like the company might have found the magic sauce to handle a weak freight market.
But the latest quarterly report from the stand-alone 3PL had landed with a thud, a declining stock price and some reductions in Wall Street analyst recommendations on the company.
The scorecard for Friday was that RXO (NYSE: RXO) stock closed down 2.27%, or 47 cents, to $20.28. The intraday low was $19.85.
However, that closing price is still above the company’s one-month low ($19.50, recorded Thursday), its three-month low ($17.50, on Nov. 10) and its 52-week low ($16.94, on Nov. 1). RXO’s stock price had been trending higher, up about 15.4% in the past three months. It’s now essentially flat for the past 52 weeks.
Thursday’s earnings report led to several actions by Wall Street analysts who follow the company.
Ken Hoexter at Bank of America Merrill Lynch (NYSE: BAC) cut BoA’s rating on RXO to neutral from buy. Its price objective had been $25 per share, but Hoexter reduced it to $22.
Bascome Majors at Susquehanna Financial Group kept his negative rating on RXO but reduced Susquehanna’s price target to $15 from $18, which already was exceeded at current levels.
At TD Cowen (NYSE: TD), the team led by Jason Seidl maintained its rating of Market Perform. But in a positive move that could be seen as somewhat mixed, it raised its price target to $19.50 — but only because it sees the company’s Enterprise Value multiple to earnings before interest, taxes, depreciation and amortization rising in 2025, which won’t be commencing for a little less than 11 months.
In a post-earnings-call interview with FreightWaves, RXO Chief Strategy Officer Jared Weisfeld said RXO historically has been able to produce brokerage margins in the “midteens.” At 14.8%, the performance in the fourth quarter was not that far from that level.
RXO was spun off from XPO (NYSE: XPO) in the fourth quarter of 2022. It did release earnings data for that quarter but had filed data with the Securities and Exchange Commission for the third quarter as well.
“We’ve consistently generated best-in-class gross margins, but it obviously depends on where you are in the cycle and whether you’re at peak or trough,” Weisfeld said. He added that there have been periods in RXO’s history, including when it was part of XPO and not a stand-alone company, when brokerage margins were in low double digits, “but you’ve also seen that get in excess of 20%.”
He said the corporate gross margin at RXO — 18% in the latest report — was above 20% in 2022, when there was a perfect margin divergence for brokers: falling spot rates feeding capacity into contractual business booked during the strong market of 2021.
Public data beginning with the fourth quarter of 2022 shows a fairly stable corporate gross margin: 19.5% in that final three months of 2022, when contractual business would have been catching up to the decline in spot rates, and then four quarters in 2023 with a corporate gross margin of 18.8%, 18.6%, 17.7% and 18%, respectively.
“I think the message there is that we have consistently strong corporate gross margins over time,” Weisfeld said.
In its comments, TD Cowen said the 14.8% gross margin posted by RXO in its brokerage operations missed the TD Cowen forecast by 120 basis points.
Merrill Lynch said the 14.8% was a 310-bps deterioration year on year, and 50 bps less than the analyst’s target.
During the earnings call, CEO Drew Wilkerson and Weisfeld said several times that RXO expects enough capacity to bleed out of the market by the second half of the year that a turnaround is likely.
But for a 3PL, that raises the reverse issue of what RXO and others benefited from in 2022: Spot rates will be rising, but contract rates will have been established during the weak days of 2023.
Weisfeld said it’s already starting to happen. “Spot pricing relative to the costs for the carriers is not sustainable, which is why you’re starting to see spot pricing move higher,” he said. In discussion of how the first weeks of 2024 went for RXO, Wilkerson said on the conference call, “Brokerage gross margin compression continued into January, and we anticipate that will impact the first quarter.”
Weisfeld said RXO “always honors its contractual rate.” How it will deal with rising spot rates alongside contractual rates established in a weaker market, Wesfield said, is that “a successful broker is going to be able to pivot to the spot market faster than anybody else.”
“If you look at our history, what’s made us successful is our contract business,” Weisfeld said. Wilkerson said on the call that contract volume was 80% of the company’s business in the fourth quarter.
RXO believes, Weisfeld said, that when it successfully services its contract customers even during times when the direction of spot rates is unfavorable relative to contract business, “then we’re going to get rewarded on behalf of our shippers with project freight, minibids, spot volumes, and that’s what we’ve seen.”
But it was mostly the negative aspects of a turning market that were featured by the Susquehanna post-earnings report on RXO. Its outlook for the company “took another step down into 1Q24 as gross margins get ‘squeezed’ by rising cost of capacity (some of this weather), pressured pricing to customers, and more profitable spot volume still rare.”
“Yes, investors are justified in being anxious about how quickly RXO can pivot to higher-priced spot business when the market turns, but management’s actions of taking costs out at the low point of a deeply challenged cycle out of their control are prudent,” Susquehanna wrote.
The reference to cost cutting was from the comments of CFO James Harris. He said on the earnings call that annualized run rate savings in 2023 were $32 million, and an additional $25 million in operating expenses is expected at RXO this year.
Weisfeld expressed optimism that the cost cuts will position RXO to be able to navigate a rising spot market for securing capacity against a backdrop of contract business set at a lower rate.
“What we’re doing is optimizing the cost structure for when that market inflection eventually occurs,” he said. And Weisfeld reiterated the timeline: “We think based on everything we’re seeing in our data base and everything that we’re hearing from our customers, based on our view of the macro economy, we can see that recovery will start to begin in the second half of the year.”
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