July 1, 2023

RXO outlook cut to negative but important debt rating not reduced


RXO has hung on to its BB+ rating from S&P Global, but the outlook on the company has been dropped down one level.

RXO, spun off from XPO (NYSE: XPO) last fall, was given a BB+ rating by S&P Global Ratings at the time the brokerage company became a separate entity. At the same time, RXO was also given a “positive” outlook by S&P, which suggested that credit and market conditions for the company were strong enough so that an increase in the rating was possible in the coming 12 months.

That move from BB+ to BBB- is one of the most significant upgrades that can occur to a debt rating at S&P Global, because it takes a company from the top level of the non-investment grade category to the lowest level of investment grade. But even the top level of non-investment grade carries the colloquial description of “junk.” The lowest level of investment grade does not.

The S&P definition of a “positive” outlook is that a rating may be increased, with the outlook going out two years for investment-grade companies and up to one year for speculative-grade companies. The stable outlook means a rating is not likely to change.

Outside of costs connected to the spinoff of RXO (NYSE: RXO) from XPO, there is nothing else in the S&P Ratings report on the company that suggests concern about its financial practices. Rather, the summary of the move from an outlook of “positive” to one of “stable” is completely connected to the state of the freight market. 

“We no longer expect RXO’s credit metrics will support an upgrade in 2023,” S&P Global said in its report, issued Wednesday. “RXO, like other truck brokers, faces a weaker freight transportation environment in 2023 following an extended period of strong pricing and demand.”

S&P also said RXO is suffering from excess trucking capacity, which has not been “meaningfully” reduced. “This dynamic has contributed to spot market pricing falling approximately 40% in recent weeks from its peak in early 2022.” 

But S&P does not just cite the status of the truckload market. Its last-mile delivery operations “face shifting consumer spending patterns, and its ocean and air freight forwarding segment is subject to weaker market conditions on key import routes.”

The “base scenario” that S&P Ratings is using in its review is that freight pricing will rise in 2024 “as some carriers exit the market.”

In the immediate term, that isn’t good news for brokers like RXO. “Typically, profitability for truck brokers is counter-cyclical,” S&P Ratings said. “Brokers generally purchase capacity on the spot market and bill customers under contracted rates on a portion of loads. Thus, margins tend to decline when spot market prices increase since brokers must purchase capacity above contracted prices.”

But even with those trends that would not be positive for RXO, S&P Ratings said its primary reason why it believes the company’s earnings before interest, taxes, depreciation and amortization will decline to 5% this year from 6.1% last year are costs associated with the XPO spinoff. EBITDA should jump back to a 6% to 7% range next year once those costs are completed.  

RXO’s first-quarter earnings were significantly stronger than peers such as C.H. Robinson (NASDAQ: CHRW), where the adjusted earnings per share was down more than 50% year on year, and Landstar (NASDAQ: LSTR), which is a less-than-perfect comparison to a more pure-play 3PL like RXO but also saw an EPS decline of more than 50%. Adjusted net income at RXO was down a little less than 40% and other measurements were seen as surprisingly strong as well. 

RXO and C.H. Robinson have both now suffered the same fate at the hands of S&P Global in recent weeks: a lowering of the outlook for the companies without a change in their debt ratings. Earlier this month, C.H. Robinson’s outlook was reduced to negative from stable but it held on to its BBB+ rating. That is three notches above the now-affirmed rating for RXO, but the C.H. Robinson debt rating is investment grade.

RXO’s first-quarter performance compared to other companies is implicitly acknowledged by S&P Ratings in its report. 

“We believe RXO will continue to outperform its peers and increase brokerage volumes,” it said. “Despite unfavorable market conditions in the first quarter, RXO reported a 6% volume increase in truck brokerage from the same period the previous year while maintaining a gross margin above its peers.”

A key reason for that outperformance, according to S&P, is that RXO “proprietary” technology “allows it to procure capacity more efficiently and improves the experience of its carriers and customers. We also believe this should support the company’s operating performance when freight conditions improve.”

S&P’s primary focus will always be on a company’s ability to finance its debt burden. The report said RXO’s credit metrics will improve next year, in part because of the reduction in costs connected to the spinoff. The funds from operations to debt ratio is expected to be about 40% next year, compared to the high 20% range this year. Debt to EBITDA will drop to the high 1x area from the low 2x range this year, S&P said.

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