RXO

Moat: 2/5

Understandability: 2/5

Balance Sheet Health: 3/5

RXO is a technology-enabled, asset-light transportation and logistics provider, primarily operating as a brokerage provider, connecting shippers with carriers through a digital platform.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

RXO operates in the freight brokerage industry, which is a highly fragmented and competitive space. Their business involves connecting shippers with carriers using a technology-driven platform. This allows shippers to find available freight capacity and carriers to find available loads, theoretically increasing efficiency in the market. Here are the key elements of their business:

  • Revenue Streams: RXO primarily generates revenue through commissions on truckload and less-than-truckload (LTL) freight transport. They are a brokerage, rather than operating their own fleet, making their operations “asset-light.” The company operates its own transportation brokerage offices, and also provides transportation solutions via a digital platform.
  • Industry Trends: The transportation industry is cyclical and fragmented, with a large number of small players as well as some big brokers and asset-based carriers. Technology and data analytics are becoming increasingly important for improving matching efficiency, predicting market dynamics, and managing costs. The industry is also affected by macroeconomic factors (like inflation, freight prices, and fuel costs). Volatility in those macroeconomic factors can impact revenues and margins negatively.
  • Margins: A key challenge in the industry is generating satisfactory profitability, as seen in Exhibit 5 within their recent 10Q report where Operating income for the most recent quarter is $15 million on $964.1 million in revenues. Gross profit margin is consistently above 10%, but the expenses, particularly fixed expenses and brokerages charges cut down profits significantly. Gross margin was about 15.9% for the most recent quarter which highlights the importance of pricing well, but also keeping costs down which include salaries, IT costs, and other expenses.
  • Competitive Landscape: The competition is significant. The truck brokerage industry is heavily fragmented, and new entrants are always eager to steal market share. In the brokerage market, several players compete through pricing and customer relationships. In the logistics technology, companies compete by using their advanced AI/ML software and advanced data analytics. Technology is a key differentiator in the industry. Companies like Uber Freight, Convoy, Transplace, XPO, and others compete in this space.
  • Differentiation: RXO’s key differentiator is its focus on technology, including proprietary algorithms for freight matching, real-time tracking of shipments, and data analytics tools for their customers and carriers. They also try to provide additional features like automated load offers, digital document management and contract automation, with the goal of making transportation more transparent and easy.

Financials Analysis

Here’s a deeper look into RXO’s financial performance. Note that the 10Q is as of September 30, 2023:

  • Revenue Growth: RXO has experienced consistent, if somewhat volatile, revenue growth. For the quarter ending September 30, 2023, the revenue was $964.1 million. The biggest factor that affects revenue is the fluctuations in freight demand. The company expects the transportation market will continue to be soft for the near future.
  • Profitability: While the company boasts a decent gross margin of about 15.9% for the most recent quarter, net income is not as impressive and they are struggling to turn profits on a consistent basis. Their operating income margin is in the range of 1-2%. Net income for the latest quarter was negative -$11.4 million, and for year-to-date is negative -$44.4 million. One of the reasons for that is higher personnel costs, higher amortization of intangible assets, and non-recurring costs relating to the spin-off from XPO. It should be noted that the high operating income in 2021-2022 was an exception and should not be expected in the future.
  • Debt and Liquidity: As of September 30, 2023, the company had $2.6 billion in debt, a large number compared to its shareholders’ equity of $1.4 billion, which is negative, meaning the company has more liabilities than assets. They also have low cash reserves ($45 million) and, to improve liquidity, they have had to borrow using revolving credit facilities, especially for operations. This highlights some risk, as this reliance on credit could hurt them if the rates were to go up significantly or if they were to lose access to such credit facilities.
  • Capital Expenditures: The company is asset-light, and so capital expenditures are low and not an area of concern.
  • Cash Flow: For the nine months ending September 30, 2023, RXO has generated -$115.2 million in cash from operating activities and spent -$50.5 million in capital expenditures. Free cash flow is therefore negative.

Recent Developments

  • Soft Freight Market: RXO’s revenue has been affected by a soft freight market environment that has persisted since 2022. Despite pricing actions, volumes have declined, putting pressure on the bottom line.
  • Cost Cutting: Management is actively cutting costs and reducing expenses while maintaining investments in technology. They were able to remove $45 million from their expenses this past quarter, and expect further cost improvements over the next quarters.
  • Focus on Value Creation: The company is focused on improving operational efficiencies and using technology to enhance the platform for their customers and carriers in order to drive long term growth and value.

Moat Assessment: 2 / 5

RXO’s business model has some elements that could potentially give it a moat, but also has limitations in its ability to create a wider sustainable competitive advantage:

  • Switching Costs: RXO does have some level of customer stickiness as once they integrate RXO into their systems they may find switching to another service provider cumbersome and costly. However, it is not a large barrier since alternatives are available and since logistics systems aren’t as sticky as other IT systems and data providers.
  • Economies of Scale and Network Effects: RXO is a larger player and their business model does allow them to scale easily because they are asset-light. A large network of shippers and carriers increases liquidity and should improve operational efficiency, but, overall, the barriers to entry are low, and the brokerage market is heavily fragmented.
  • Intangible Assets: RXO has some intangible assets relating to their proprietary software but those don’t seem to be able to protect their margin against competitors. Other brokerage companies can come in and develop similar software at similar costs.
  • Limitations: Their lack of asset ownership means that they don’t have a strong grasp on their assets, and they are easily replaceable. There is intense price competition as their offerings are similar to other players, and the low profitability means that they are vulnerable to pricing swings.

Risks to the Moat

Several risks threaten the company’s competitive position:

  • Economic Downturns: The freight brokerage industry is cyclical and relies heavily on a healthy economy and consumer spending. Recessions can negatively affect their business.
  • Increased Competition: Intense price competition from other players, including brokers, aggregators, and larger asset-based carriers can lower their revenue and their profits.
  • Technology Disruption: New tech competitors or better AI/ML algorithms might cause RXO to lose its competitive edge.
  • Customer Consolidation: A consolidation in the shipping industry could reduce the number of clients and thereby increase their negotiating power.
  • Reliance on Credit Markets: As we mentioned before the reliance on credit markets can become problematic if they lose their credit facilities or the rates significantly increase.

Business Resilience

RXO has reasonable resilience, but this is mostly attributable to its asset-light model. They don’t have to incur high capital costs to buy their own trucking and logistics equipment. That makes them resilient if a downturn or a slow freight market happens. Their low expenses give them a bit of a cushion to operate, but they are still struggling to become profitable in a consistently way.

Understandability: 2 / 5

The business is not particularly complex to understand, it is a brokerage that uses technology. However, determining the different strategies that this company is implementing in an effective way, as well as forecasting future revenue, growth, and margins is complex and needs a high level of domain-expertise.

Balance Sheet Health: 3 / 5

While they have reasonable cash and flexibility, their debt to equity ratio is low as they have more liabilities than assets. This presents some risks, especially if the market turns on them. Their long-term debts and the amount needed for operations are areas of concern. However, their asset-light business makes it easier to adjust to economic and market downturns.