Steer Clear of XPO Logistics

 | Jul 12, 2013 | 4:30 PM EDT  | Comments
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According to a 13G filed with the Securities and Exchange Commission (SEC), Bares Capital Management has increased the size of its position in XPO Logistics (XPO) to a total of 1.9 million shares. Brian Bares manages the fund, which tends to focus on small-cap and microcap stocks, and he has published a book on the subject: The Small Cap Advantage.

XPO, a freight brokerage, expedited transportation, and logistics company, is indeed a smaller-cap stock with a market capitalization of about $340 million (on average over 160,000 shares are traded per day, so at the current price of about $19 per share, it has more than $3 million in daily dollar volume). The recent increase in the fund's stake (it had reported owning 1.2 million shares as of the end of March) gives it ownership of a little over 10% of the total outstanding shares.

XPO has been fairly acquisitive over the last year. Most of its acquisitions have been small companies at valuations of less than $10 million, but there was one significant $50 million deal. As a result, the company's revenue and expenses have grown enormously -- revenue more than doubled in the first quarter of 2013 vs. a year earlier. However, XPO's losses have piled up as well. The most recent 10-Q shows $0.85 in losses per share for the first quarter, compared to losses of $.036 per share in the prior year period.

Cash flow from operations was negative $28 million for the quarter, and the company drew on its cash position to help make acquisitions as well. At the end of March, XPO had about $200 million in the bank. We would note that even with the business carrying a good deal of debt as well, the enterprise value is only about $250 million. Still, earnings before interest, taxes, depreciation and amortization (EBITDA) has been negative, so we can't really evaluate the stock on a cash flow basis.

Nearly all of the revenue growth came from the freight brokerage segment, which houses many of XPO's new acquisitions. This made up about two-thirds of revenue for the first quarter of 2013 (up from about 20% a year ago). Losses in this segment have at least temporarily widened -- as well as increased the corporate expenses – which is a major factor in the company's troubles. It's possible that the company will better integrate its new acquisitions over time and, therefore, realize synergies. But we would be concerned about integration risk and the fact that, on average, mergers and acquisitions (M&A) destroy shareholder value. In this case, XPO seems to have concentrated its acquisitions on what had previously been a smaller part of its business as opposed to strengthening a "core competency."

Consensus forecasts from Wall Street analysts are that XPO will lose $2.12 per share this year, which would be a steep loss for the company -- and actual results have come in below expectations in the last two quarterly reports. There are a wide spread of predictions for 2014, which average out to about zero profitability, so any investors are depending on XPO turning decent profits beyond that point.

Many market players are bearish on the stock: The most recent data reports show that 22% of the float is held short. Statistically, the stock is highly dependent on broader market conditions with a beta of 2.4, even though cash is a large share of its market cap.

We don't know what Bares and his team see in XPO. The company is currently losing money, and has shifted its focus to a segment that currently has negative operating income with losses per share rising considerably as a result. In fact, cash flow from operations is negative, which is certainly a bad sign. In addition, the company's  acquisitions could create integration risks and even the normally optimistic analyst community is generally expecting little to no earnings next year. We would avoid the stock.

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