GXO Logistics: Leading Indicators Suggest A Robust Growth Outlook (NYSE:GXO)

Summary

Following my coverage on GXO Logistics (NYSE:GXO) in Feb’24, which I recommended a buy rating as underlying demand trends were moving in the right direction, this post is to provide an update on my thoughts on the business and stock. I reiterate my buy rating for GXO as the outlook has gotten better. Various macro indicators and GXO’s organic business wins paint a robust growth outlook for the near term, which gives confidence that the business is on track to meet its FY27 targets.

Investment thesis

On 06-08-2024, GXO released its 2Q24 earnings, which saw revenue growth of 18.9% y/y from $2.39 billion to $2.85 billion. The strong growth was mainly driven by acquisitions, which contributed ~16.5% of 2Q24 y/y growth. Adjusting for M&A contribution, organic growth saw 2.5%, an acceleration from the <1% seen in 1Q24. That said, adj. EBITDA fell by 1.6% to $187 million (note: this still beat consensus expectation for $182 million). Adj EPS fell from $0.70 to $0.55 as a result. I am not too worried about the soft EBITDA performance, as it was mainly dragged down by the Wincanton acquisition (integration cost). Management noted that they remain well positioned to achieve the $55 million cost synergy targets.

I remain upbeat about GXO’s upcoming performance, as the various metrics that I have been tracking all paint a positive outlook. At the macro level, the recovery in UK and European retail sales are tailwinds for GXO, and the acceleration in organic growth in 2Q24 is reflecting this, I believe.

1. In the UK (45% of 2Q24 revenue), while there has been some volatility in y/y growth, the overall trend is positive compared to last year. Retail sales should continue to trend positively for a few reasons. Firstly, the central bank lowered its interest rate recently, which should translate to better economic growth. Secondly, consumer purchasing power has increased as the National Living Wage in the UK increased 10% from £10.42/hr to £11.44/hr in April, and inflation is trending downwards nicely.
2. Likewise, for Europe (23% of 2Q24 revenue), y/y retail sales growth has turned positive this year. The same dynamic as in the UK is happening in Europe as the central bank has opted to cut rates.
3. As for the US, I think the timing of recovery is near (though hard to pinpoint) as the feds have signaled to cut rates in September, which, I believe, is highly likely given the labor market has eased. Though the current US headline narratives point to a poor consumer spending environment, if we look two quarters ahead (assuming rates get cut and inflation continues to taper down), I expect the demand environment to improve significantly.

Moving down to the micro level, GXO signed $270 million of new business wins in 2Q24, and the pipeline grew for the third consecutive quarter to a 12-month high of $2.3 billion. From a revenue contribution perspective, GXO has already locked in ~$796 million in incremental 2024 revenues from new contract wins, which represents ~860 bps of organic revenue growth (this is a step up from the $676 million signs for 2024 reported in the last quarter), and this bodes well for FY24 performance. Importantly, a key indicator that GXO is benefiting from demand recovery is that contract lengths are getting longer and deal sizes are getting larger—both indicators that clients are getting confident in upcoming demand and/or actually seeing strong underlying demand.

Cycling back to profit margins, I am keeping a positive view on long-term margin expansion as GXO seems to have stepped up its focus on automation. For instance, they have deployed humanoid robots in live sites and implemented AI in GXO sites to optimize fulfillment, with the expectation that FY24 will have 10x more deployed sites than FY23. While these initiatives will take a while to get implemented, practiced, and ramped up, I believe the investments made today will reap huge benefits over time.

Of course, there is a ramp up period of automation, but once it comes at a mature level, it is quite profitable and it’s very efficient. 2Q24 earnings results call

Looking ahead, management also sounded confident in their guidance. They reaffirmed their organic revenue, EBITDA, and EPS guidance for FY24 and their confidence in reaching FY27 targets. Notably, management noted that the next peak season is going to be stronger than last year due to improving inventory levels (take the US, for example, where retailers are nearing restocking levels) and how customers are reacting to the potential recovery ahead.

But we can see that our customers, particularly the consumer focused customers, they are starting to plan out really now for a holiday season. Last year was a very disappointing holiday season.

we feel confident that we have passed the bottom as Malcolm highlighted, we are expecting a better peak compared to Q4 of 2023, which was really, really and we already seen this environment reflected in our current business. 2Q24 earnings results call

Overall, as I see it, I think various data points put together paint a positive outlook for GXO.

Valuation

2Q24 performance (organic growth acceleration and acquisition contribution) and recent macro trends (improving retail sales and inventory levels) have convinced me that GXO is on track to meet its FY27 growth targets. Depending on how bullish one is about the macro-recovery strength, the upside varies from ~20% to 91% based on my scenario analysis. In my weakest scenario, I assumed EBITDA to grow at 5% CAGR (slightly above GDP levels and assuming little margin expansion), whereas in my bullish scenario, I assumed GXO to meet the $1.6 billion adj. EBITDA guidance (note this was before the recent acquisition). The other variable attribute is the multiple that GXO should trade at. While I like to think that multiples can go higher because of the growth outlook, I am assuming a 20x P/FCF multiple (where GXO is trading today). Any upside revision is an added bonus to total returns.

Risk

The timing of macro recovery remains the biggest risk to going long GXO today. Early indicators have indicated a positive outlook, but things could flip for the worse if consumer demand stays weaker for longer than expected. While the US is a relatively smaller part of GXO’s business, the market is likely to punish GXO’s share price if the headline narratives remain negative (the recent share price movement clearly does not reflect the improvements seen in Europe).

Conclusion

In conclusion, my rating for GXO is a buy, as the 2Q24 performance and forward outlook are very positive. In particular, the acceleration in organic growth, robust pipeline of new business, and favorable macrotrends suggest robust growth ahead. GXO’s strategic focus on automation also positions it well for long-term margin expansion. Based on these factors, I reiterate my buy rating on the stock.