Description

Overview:

GXO Logistics is the largest pure-play global contract logistics company. In August 2021, GXO was spun off from XPO Logistics, a diversified transportation company, with holders of XPO receiving one share of GXO for each share of XPO held. A key motivation for the separation was to unlock shareholder value by eliminating the conglomerate discount embedded in XPO’s shares. The majority of the businesses that constitute GXO were assembled by Bradley Jacobs, who currently serves as chairman at GXO. Mr. Jacobs has successfully rolled up a number of industries during his career. Notably, two of his rollups, United Rentals (which he founded in 1997 and led for 10 years) and XPO (founded in 2011), were among the top 20 performers within the Fortune 500 for the 10 years ended 2021.

After reaching a post spinoff high of ~$100 a share in late 2021, GXO’s shares were pressured during 2022 declining by ~65% to ~$35 a share before retracing some of those losses throughout 2023 thanks to a favorable long-term outlook communicated at a January 2023 investor day and strong 1Q 2023 earnings report in early may that prompted the Company to increase a number of key guidance items for 2023. The share price pressure reflected macroeconomic uncertainty and FX headwinds with GXO entering a large acquisition (Clipper Logistics) that bolstered its presence in Europe just as the war in Ukraine was breaking out. Although the timing of the Clipper acquisition was not ideal, management has recently noted that it is exceeding its internal expectations. We believe that GXO’s business model is underappreciated by investors as its long term contracts (5 year average contract duration) and strong client retention (~95%) offer good revenue and cash flow visibility. During a recent investor day, GXO stated that it expects to generate 8-12% annual organic revenue growth (through 2027) with revenue increasing to $17 billion up from $8 billion in 2021. Meanwhile, GXO is expected to generate ~$2 billion in free cash flow (cumulative amount) between 2021 and 2027, representing ~30% of the Company’s current market cap. 

Business Description:

GXO Logistics, Inc., is the largest pure-play contract logistics provider in the world and is a leader in cutting-edge warehousing and distribution, including e-commerce logistics. GXO provides its customers with high-value-add warehousing and distribution, order fulfillment, e-commerce and reverse logistics (also called returns management), and other supply chain services. The Company currently operates in 27 countries through 974 warehouse locations that include ~200 million square feet of total warehouse space split fairly evenly between Europe and North America with a much smaller presence in Asia. In 2022, GXO acquired Clipper logistics (~$1.1 billion), which we believe will be a game changer. Clipper has almost no customer overlap (cross selling opportunities), has sophisticated software for reverse logistics and bolsters the Company’s presence in Germany giving it critical mass in that region. Although leverage increased to over 2.0x following the acquisition, the Company is rapidly delevering and should end 2023 at just 1.5x net leverage. 

Why Does this Opportunity Exist: 

Large Insider Sale: Subsequent to the spin off, GXO chairman and company founder Brad Jacobs has significantly reduced his stake in the Company. Chairman Jacobs has sold down his GXO stake from 13.5% at the time of the spin off to 1.4% presently (he has also sold down his stake in XPO in a similar fashion). Although the share sales are large, we don’t believe they are a reflection of the Company’s future prospects (Mr. Jacobs has publicly stated that he is on the prowl for his next big investment opportunity). We note that Mr. Jacobs had also sold large stakes in his previous rollups that would ultimately go on to generate strong returns after his sales. 

Macro Economic Uncertainty:  A combination of macroeconomic uncertainty and FX weakness weighed on GXO’s shares in 2022, especially following the acquisition of Clipper. However, we believe these concerns are starting to abate and note that the Company’s increased full year outlook in May 2023 helps reinforce this view.  

Lack of Pure Play Publicly Traded Comps: There are no pure-play publicly traded competitors for GXO. As a result, we believe that investors don’t fully appreciate the Company’s attractive business model characterized by long-term contracts and strong customer retention (discussed in additional detail below). At current levels, GXO sells for ~11.5x EBITDA, though this multiple represents a substantial discount to companies with business models whereby revenues are secured via long-term contracts  including firms such as Cintas (24x), Marriott (15x) and Aramark (14x). 

Misunderstood Business: In our view, The Company’s business model is misunderstood by investors. The business operates with EBITDA margins that are currently less than 10%, however we note that a  large amount of the Company’s expenses are lease payments that are effectively a pass through. 

Contract Uncertainty: GXO doesn’t disclose much information about its long-term contracts, which has created investor uncertainty, especially in the recent inflationary environment. However, the Company does have the ability to pass through inflationary costs to its customers. Within its open book contracts (~45% of revenues), all costs are passed through to customers. The hybrid closed-book contracts, which account for the balance, have built in inflation escalators. Notably, GXO’s contracts are written for returns that generate greater than 30% returns on invested capital.

Muted Near Term Outlook: Although GXO recently communicated a strong long-term outlook (discussed in more detail later), its  initial outlook for 2023 calling for organic growth of 6% to 8% was a little disappointing as was its outlook for adjusted EBITDA of $700-$730 million. Management attributed the 2023 growth outlook (which is below its long term growth outlook guidance) to cautiousness amid macro economic uncertainty though we note that the Company’s adjusted EBITDA outlook was increased to a range of $715 to $745 million in conjunction with its 1Q 2023 earnings. The Company also recently announced its largest ever contract ($1 billion in revenues) with Sainsbury, which should boost GXO’s short and long term prospects. 

Attractive Business Model:

GXO boasts an extremely attractive business model. Its favorable characteristics include long-term relationships with blue-chip customers (GXO’s top 20 customers have been with the Company for 15 years on average), strong customer retention and long-term contracts that provide significant revenue and cash flow visibility (~95% customer retention, with ~80% of revenues generated by customers that have been with the Company for more than 5 years), resilient revenues due to the nature of its customer base (with ~76% of revenues derived from customers in non-cyclical end markets), and minimal capital requirements (with maintenance capex averaging just 1% of total revenues).

Competitive Advantages:

GXO boasts many competitive advantages including its scale (4x-8x larger than pure-play peers); investment in technology and automation (GXO’s proprietary technology are its Smart tools and analytics, which it has deployed across 85% of its sites in North America and 50% of its sites in Europe); and direct shared space distribution, which gives customers, including retailers, e-tailers, and manufacturers, access to GXO’s scale, expertise, and technology while avoiding the high fixed costs associated with traditional distribution center models. Although GXO does not manufacture the robotics technology used in its warehouses (it purchase these products from third parties), GXO believes that its “secret sauce” is its ability to pair its proprietary/internal warehouse software with its various robotic technology and automation devices (robots, cobots, etc.).

Growth Opportunities:

Outsourcing: The current addressable market is $130 billion, but the total addressable market is believed to be a $430 billion opportunity and includes $300 billion of currently insourced logistics in North America and Europe. Notably the total addressable market of the warehousing market is expected to increase to $660 billion by 2027. The underpenetrated nature of the logistics market, coupled with its highly fragmented composition, should provide meaningful growth opportunities for years. During a 2021 Roadsigns Podcast, Mark Maduca, who serves as GXO’s CIO stated, “...everything is going to gravitate towards supply chain managers like ourselves who can provide four major things: scale, global [footprint], so being able to do things across a number of countries; a strong balance sheet, so effectively being a good partner, you know, from a leverage standpoint; and also being able to bring technology into the mix as well. And I think that that’s really going to win out in this in this e-commerce growth story, that is going to be more than just a 1-, 2-, 3-year phenomenon. This is going to run for 20-30 years, I believe”

E-Commerce: The secular growth of e-commerce, which has substantially outpaced growth in the broader economy for years, accelerated during the recent shift in consumer behavior to online buying during the pandemic. GXO is a global leader in e-commerce logistics, with the largest outsourced e-commerce platform in Europe and an expansive platform in North America providing order fulfillment and reverse logistics. E-commerce sales as a % of the total retail sales increased from ~15% in 2019 to ~22% in 2022 and are expected to reach over 30% by 2025. Notably, when a GXO customer switches to e-commerce, GXO receives a 3x-10x revenue uplift. During GXO’s 2023 investor day, CIO Manduca stated, “...unlike traditional brick-and-mortar, with eCommerce, each item needs to be sorted and separated, and individual packages need to be created to be shipped to the end consumer. This creates demand for a far greater degree of sophistication throughout the fulfillment process, and a compelling revenue-multiplier effect for GXO.”

Automation: Although GXO has been investing in automating its warehouses for over a decade, the automation of warehouses is still in its infancy, with just 5% of warehouses in the U.S. and Europe automated. According to data from Prologis, automation of facilities in the U.S. stood at approximately 20%-25% though penetration in the EU is much lower. We would expect companies to increasingly turn to automation as a result of recent tight labor market conditions and to counter various other supply chain cost pressures that have become more prevalent during the pandemic. According to GXO, autonomous goods-to-persons systems can improve labor productivity by 4x-6x, and cobots, which assist workers with the inventory picking process, can improve productivity by 2x on average. Moreover, stationary robot arms can repeat demanding tasks with precision 3x faster than is possible manually. Another key consideration for increased adoption of automation is that automated facilities are estimated to be 33%-300% larger than sites without automation technology, which suggests the potential for outsized revenue from these facilities.

Reverse Logistics: With online consumers now accustomed to free shipping and free returns and increasingly “test driving” products they purchase on the Internet, GXO stands to play a major role in reverse logistics or the return of goods after they have arrived at a consumer’s home. According to GXO, online returns offer a revenue opportunity that is 2x-5x greater than the revenue it generates from customers that only ship outbound parcels. Historically, 1 out of every 10 items purchased by consumers was returned, but return rates have increased significantly and now stand at about 1 out of every 3 items. Notably, the business of processing returns has been one of the fastest-growing revenue drivers of the e-commerce business increasing at a nearly 16% CAGR over the past 3 years. Management sees the reverse logistics business accelerating going forward, which is more profitable for GXO. According to GXO, customers where GXO provides reverse logistics services carry significantly higher margins (~11% EBITDA margins vs. 8.1%). 

Clipper Revenue and Cost Synergies: GXO expects to realize significant cost synergies from its 2022 acquisition of Clipper that will boost EBITDA by about 36 million pounds annually by 2025. In addition to the cost synergies, GXO expects to generate “hundreds of millions” in revenue synergies from cross selling opportunities in new customers, geographies, verticals and services. The acquisition of Clipper brings GXO a highly developed electronic repair (refurbishment) capability for returned electronic goods for retailers and manufactures that GXO plans to leverage across its customer base. 

M&A: The logistics market is highly fragmented with the top five players having an ~25% market share (GXO’s share is ~7%). The highly fragmented nature of the market should provide GXO with meaningful growth opportunities (via M&A) for many years to come. 

Robust Long-Term Outlook:

GXO communicated a robust long-term outlook at its 2023 investor day. Key components of the outlook including the following:

Revenue: 8-12% organic revenue growth, with revenues increasing to ~$17 billion from $8 billion in 2021. 

Adjusted EBITDA: Adjusted EBITDA nearly tripling to ~$1.6 billion from the $633 million in pro forma adjusted EBITDA reported in 2021

Free Cash Flow: Cumulative free cash flow generation of ~$2 billion between 2021 and 2017 representing about 30% of GXO’s current market cap. 

Valuation:

As noted above, we believe that investors have had trouble valuing GXO Logistics due to the absence of any pure-play publicly traded comps. However, we note that businesses with a large amount of contracted revenue currently command EV/EBITDA multiples in excess of 15x. It is also worth noting that recent M&A in the logistics space has transacted in the high-teens EBITDA multiple range. Should GXO be able to command a mid teens multiple, we believe that there would be significant upside from current levels. 

Catalyst

• Continued growth in e-commerce penetration

• Ongoing outsourcing of contract logistics services

• Cross selling of Clipper’s refurbishment services across GXO’s customer base

• Increase in warehouse automation

• M&A opportunities in the fragmented logistics market

• Realization of revenue and cost synergies from the 2022 acquisition of Clipper