GXO Logistics: Underlying Trends Are Painting A Positive Outlook (NYSE:GXO)

Summary

Following my coverage on GXO Logistics (NYSE:GXO), for which I recommended a buy rating as I expected solid FY23 performance, which coupled with an attractive valuation makes it a buy, this post is to give an update on my thesis. I continue to give a buy recommendation for GXO because the underlying business trends point to a positive outlook. With this momentum continuing and if rates in key GXO regions are cut, GXO should have no issues growing according to its FY27 organic growth guide.

Investment thesis

For 4Q23, GXO posted revenue of $2.59 billion, equating to 5% y/y growth, beating consensus estimate of $2.55 billion. Adj EBITDA came in line with expectations at $193 million, but adj EPS came ahead modestly at $0.70 vs. the $0.68 consensus estimate. On a FY23 basis, organic revenue growth was 2.3%, which is within the management-guided range of 2% to 4%, while adj. EBITDA of $741 million was way above the guided range of $700 to $730 million. Adj EPS also came in better than guided at $2.59 vs. the range of $2.30-$2.50.

2H23 were tough periods for GXO because of the macro situation: inflation stayed high, the job market remained hot, and the US housing situation continued to remain undersupplied, all of which led to rates staying at their current high level (relative to the past decade). My mistake was being too bullish in expecting a recovery (I expected 10% growth for FY23 previously). The slowdown in growth led to share price weakness, falling from $67 to the current $53 level. Management FY24 guidance also seemed weak from a headline basis, which I believe further contributed to the weak share price movement over the past 2 weeks.

That said, I believe GXO growth will only get better from here, with the potential to beat guidance. The Management outlook for FY23 is 2 to 5% organic revenue growth, and if we include the contribution from the PFSWeb acquisition last year (around 200bps based on my calculation), reported growth for FY24 should be higher than organic growth. The primary reason for my bullish take here is that the underlying business trends are pointing to a positive growth outlook in FY24. The main indicator that I tracked for GXO is retail sales activity across GXO key regions: UK (37.% of sales); US (30% of sales); Netherlands (8.5% of sales); France (8.5% of sales). Collectively, these key regions account for ~85% of GXO revenue.

Starting with the UK (1^st chart below), from the data available, we can see a clear positive trend in retail sales recovery since the 4.7% decline seen in 1Q23 and have turned positive for January 2024. According to the latest trend, UK retail sales strength continues to see momentum, and I expect this to have an outsized impact on GXO growth in FY24, especially considering the business is going to lap a very weak FY23. As for the US (2^nd chart below), a similar trend could be seen from the lows seen in 1H24, where retail sales accelerated against a high FY22 base. While February retail sales seemed weak, not on a 2-year stack basis (Feb ’23 was a high base), retail sales remained resilient at ~5%. With inflation down from the 6+% level, it is increasingly likely that the Fed will start to cut rates, which should have a positive indirect impact on consumer spending in 2H24. Again, I expect GXO to benefit from this. Next for the Netherlands and France, the headline narrative was that Europe would be heavily impacted due to the impact of the Ukraine war on energy prices; however, retail sales have proven to be a lot more resilient (the Netherlands stayed positive throughout last year while France showed a positive recovery). The inflation situation in Europe has also come down, similar to the US, and with the possibility of a rate cut this year, I expect Europe to follow a similar trend as the US and UK, a positive one.

These indicators are supporting, and management comments that organic growth rates hit bottom in 4Q23 support my view of growth acceleration in FY24. Notably, new business wins are already locked in for FY24/25. In 2023, GXO brought in over $1 billion in new business on an annualized basis, with 40% of that total coming from customers who outsourced operations that were previously handled in-house. GXO has also secured >$500 million in additional revenues for 2024, which equates to =>500 bps of gross organic revenue growth—more than the high end of the growth targets for FY24. Furthermore, GXO has secured $230 million in additional revenues for 2025, which equates to approximately 250 bps of gross organic growth.

We signed $1 billion of annualized new business wins positioning GXO for continued growth. We deployed a record amount of automation, helping our customers to operate more efficiently.

Roughly, half of our $1 billion new business won in 2023 will go live in 2024, and we already booked nearly $230 million of additional incremental revenue for 2025. 4Q23 earnings results call

We’ve got $520 million of incremental revenue booked for 2024 and nearly $200 million of incremental revenue booked for 2025. In the third quarter, almost half of our new business wins were outsourcing. 3Q23 earnings results call

Valuation

With the underlying indicators pointing to a positive growth outlook, combined with management commentary that organic growth has plateaued in 4Q23, I am confident that growth can accelerate back to management long-term guidance over the next 2 years (the midpoint of the organic growth guide). However, contrary to my expectations previously, I have adopted a more conservative approach to modeling the upside. I am assuming that GXO makes no M&A to drive additional growth (i.e., only grows organically). With these assumptions, I expect GXO to generate ~$14 billion in revenue, $1.25 billion in adj. EBITDA (using the same margin expectation as in the long-term guide), and FCF conversion to remain at 37% (in line with guidance of >30%) through FY27. Attaching a 22x forward P/FCF multiple for GXO, which I think is appropriate relative to its historical 29x multiple because of the current high-rates environment (which pushes down equity valuation due to the high cost of equity), my target price for GXO based on my model is ~$85.

Risk

A large part of the expectation for growth recovery is macro conditions to improve from here, as seen from the retail sales data. However, this might not play out as I expected. There is visible geopolitical risk that could turn the global economy into a negative state, for instance: the Red Sea conflict threatening the supply chain. If this Red Sea conflict worsens, freight cost could go higher, resulting in higher prices (for consumer-facing products), hence, dampening retail sales performance.

Conclusion

I maintain my buy recommendation for GXO as underlying trends signal a positive outlook. While 2H23 posed challenges due to high rates and macroeconomic conditions, the FY23 results beat expectations, with organic growth hitting the lower end of the management-guided range. Despite a recent share price decline, I believe GXO’s growth trajectory will improve in FY24, fueled by positive retail sales trends in key regions (UK, US, Netherlands, and France). My conservative model, excluding M&A, forecasts a target price of around $85. However, potential geopolitical risks, such as the Red Sea conflict impacting the supply chain, pose a threat to the macroeconomic recovery and subsequent retail sales performance.