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XPO’s debt rating gets 1-notch upgrade

Almost eight months after signaling such a move, S&P Global Ratings has raised the debt rating of XPO Logistics.

XPO (NYSE: XPO) had been put on CreditWatch positive in June. Such a move does not guarantee a higher rating but is usually a precursor to one.

In the latest move, XPO’s debt rating was raised to BB+ from BB. That places it one notch under the level that would rate the company’s debt as investment grade. At BB+, it is still considered speculative, but that is the highest rating in the speculative spectrum.

Helping drive the move was XPO’s decision to use $408 million of the funds it received for the spinoff of RXO (NYSE: RXO) to reduce debt. That move brought the company’s recent debt reduction total to $1 billion. 

S&P Global Ratings (NYSE: SPGI) focuses solely on a company’s ability to repay its debt. It is not an opinion on the company’s common stock, which is up almost 31% in the last three months and a little less than 6% in the past year, after being in the red on a 12-month comparison for much of 2022. 

Although XPO pulled back on its plans to divest its European operations, when that spinoff finally comes, S&P Global said that “it is likely the company will use the divestiture proceeds to support debt repayment at XPO, similar to its actions following previous divestitures.” Despite that, S&P said it is not building future debt repayments from divestiture proceeds into its model for XPO’s ability to service its debts in the future. 

Additionally, with XPO now getting more than 85% of its EBITDA from its North American LTL operations, according to S&P, selling the European operations “is unlikely to result in a change to our view of XPO’s competitive position.”

Earnings before interest, taxes, depreciation and amortization is a key metric for ratings agencies, as it is out of EBITDA that debt repayments are made. 

The other key metric for ratings agencies like S&P is free operating cash flow (FOCF), since that also helps determine the level of debt repayment. XPO, according to S&P, will have positive FOCF in 2023 and an improved rate in 2024. Specifically, S&P said it expects FOCF will be $70 million to $90 million in 2023, rising to $275 million to $300 million next year. 

With the combined impact of greater FOCF and higher EBITDA, the result should be a funds from operation (FFO) to debt ratio in the low 30% range this year, rising to the high 30% range next year, S&P said. 

XPO finished the third quarter of 2022 with $544 million in cash on its books, a big increase from the $260 million it reported at the end of 2021. S&P said it expects cash balances this year will be between $350 million and $400 million but rising to $575 million to $624 million next year. 

According to S&P, RXO contributed about 21% of XPO’s total EBITDA in 2021. And in a review of the overall financial performance of several XPO former or current divisions, the case for making XPO an LTL stand-alone is clear: Between 2019 and 2022, according to S&P, RXO’s unadjusted EBITDA margins were 4% to 6%, intermodal of 15% to 21% (which has been divested), and the still-owned European operations had a negative EBITDA of 1% to 3%. 

“Once the company divests the XET segment, we believe EBITDA from North American LTL will be the future margin profile of XPO,” S&P said.

But ironically, despite that lower EBITDA, RXO’s rating from S&P Global is identical to its one-time parent. 

S&P Global does not just comment on a company’s financial performance; some opinions on operations generally make their way into its ratings. For example, S&P said the spinoff of truck brokerage RXO is another step making XPO a pure-play LTL company because RXO had exposure to the truckload market. 

“We view the truckload market as more fragmented with less pricing discipline and therefore comparatively more volatile,” S&P wrote.

It also noted that revenues from RXO and the European division can be misleading, because they are mostly pass-through expenses “leading to higher revenues and lower margins historically.”

Comparisons of XPO’s debt rating to peer companies are difficult as few other LTL carriers have publicly traded (and therefore publicly rated) debt. Yellow Corp. (NASDAQ: YRCW) carries a debt rating of B- from S&P Global and B3 from Moody’s (NYSE: MCO), which are considered equivalent. It is five notches down from the most recent XPO rating. 

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