Okay, so up next, we have RXO, and I'm pleased to welcome Chief Strategy Officer Jared Weisfeld. Jared, thanks for coming.
Thanks, thanks for having me. Appreciate it.
Great. So, you know, RXO has been, I guess, a relatively new story in the stock markets. You know, I don't know, IPO two years ago. Why don't you tell us about RXO first, maybe, and then we can, you know, unfold some of the things.
Sure. So we spun out of XPO in 2022, so it just came up on our two-year anniversary. And we were formerly the North American Transportation Division, as part of XPO. So when you think about what composes, what makes up RXO, it's our truck brokerage business, which has got a lot larger after completing the acquisition of Coyote Logistics from UPS. And it's two complementary services: managed transportation and last mile. So within the truck brokerage space, we are now the third-largest truck brokerage in North America. We've grown the fastest, as legacy RXO over the last 10 years, with some of the strongest margins in the industry, where we've got, you know, call it Fortune 100, Fortune 500 customers, and now with Coyote, almost 150,000 carriers. So really connecting the shippers, connecting the carriers, doing it with very strong margins.
This is a massive industry, $400 billion for-hire truckload market, where brokerage has tripled their penetration as an industry from mid-single digits to low 20% over the last 15 years. We think there's strong secular tailwinds for that penetration rate to continue to move higher. On the managed transportation side, that's when RXO acts as the transportation department on behalf of our shippers. Right now, we've got about $3 billion of freight under management. We were awarded over $300 million of freight under management in Q3. We're onboarding more than $400 million in Q4. That business will be close to $3.5 billion of freight under management by the end of the year. The last mile, we are the largest in big and bulky in the United States from a home delivery standpoint.
Think about electronics, appliances, fitness equipment into the home, where we operate a large network of last-mile hubs, and we cover, you know, a vast majority of the U.S. population within 125 miles. That's a quick overview of RXO.
That sounds like a very big franchise there that you have to manage there. Great. Thanks for the overview. So maybe we can unpack a few things here. You know, I cover freight sector. So, you know, I've seen in my space, obviously, a lot of these trucking companies, rails, and, you know, other freight companies, they're all talking about supply-demand imbalance, probably for the last one and a half years or so. You know, what do you think, you know, what's the dynamic like right now in terms of, you know, the freight recession, where we are, the supply-demand imbalances and all that? And how do you kind of fit in? How does the brokerage business fit in, in that supply-demand equation?
Yeah. So we've been in a prolonged soft freight environment for, coming up on three years now. And you're right, there's been an imbalance where there is too much truckload supply relative to the amount of demand that's out there. The good news is that supply has been coming out every month for, over two years now. So we are certainly in a better position from an industry standpoint with respect to supply-demand. And we do think that the market is now more susceptible to changes in demand relative to any time over the last two and a half years. So that's good. But there is still too much truckload supply relative to end demand.
And the problem there is just rooted in carrier unit economics, where, you know, many carriers right now, especially the small owner operators, you look at their cost per mile relative to current spot rates, and it's unsustainable. But it's been that way for a while, right? So, I think, you know, I think the big question now is, when are we gonna see the increase in demand to get us to the next stage of the freight cycle? And when we reported earnings last week, and we talked about seeing some encouraging signs in terms of the overall market. Tender rejections are now at year-to-date highs, through 6%. Load-to-truck ratio is now north of 4 to 1. And linehaul spot rates have moved higher, almost to $1.60 a mile. So those are encouraging.
We still are expecting a muted peak season, but I do think that what we've seen over the last couple months in terms of the trajectory of freight metrics, they are all moving in the right direction. I think the question is, when do we get to that recovery, which we're still waiting to see.
Yeah, I guess. I think that's been the number one question for the last six months or so. You know, when's the bottom, and where's the bottom? I think we're seeing some signs maybe, but, you know, talk to us about how you have grown, during the speed, organically, if at all. You know, like, what has driven that growth on the volume side?
During the spin or post-spin? So if you think about RXO's legacy business prior to the acquisition of Coyote, despite being the soft freight environment, last quarter, our full truckload contract volume grew by over, over 30% on a three-year stack. So I think that speaks to the really strong customer relationships, the really strong technology suite that we offer our customers. And our fundamental belief is that, and we've seen this over the last 10, 15 years, those deep contractual relationships will lead to spot opportunities when the market does turn. We saw a little bit of that in the month of October for legacy RXO. We saw some special spot opportunities. We saw some hurricane relief loads, due to the hurricanes in North America or in the U.S. from Milton and Helene, and we were customers' first call.
We saw some of that. We think that, you know, you look at our contractual book of business on the RXO side, right now it's about, you know, call it 70%-77% contractual and 23% spot. You think about when the market does finally recover, you know, that spot has been as high as 40%. We are at the low end of our spot exposure, which I think is consistent with our view that we're at the bottom of the cycle.
Right. That's great. And you mentioned about the rates, right? You know, I think we have seen some sort of softness in the spot markets clearly, but I think we're also seeing some signs of flattening or bottoming here, right? You know, talked about tender rejection. I think we have seen, obviously, that data point. I think it's turning maybe inflecting slightly positively here or something. You know, in terms of the rates, you know, do you think, A, first of all, like, the rates have troughed or not? And, you know, what's the path from here? And then, you know, anything you're seeing in terms of your discussions with customers, you know, what, what are they telling you? Like, you know, is there a pricing power that comes back to the industry right now?
Yeah. So it's a great question. And I think that I'll build on the prior comment that rates right now for carriers are unsustainable. And I think that goes back to the unit economics that I was referring to in terms of where carrier costs are relative to the current spot environment. So I'd agree with everything you're saying. And I think what we said last week on our earnings call was, as we think about, you know, where rates are going over the next 12 months, I think as a starting place, you know, up low- to mid-single digit is probably a good place to think about. So I think that'll heavily depend on the trajectory in terms of demand and how to think about what may or may not occur with the new administration and how that impacts overall freight demands.
But that's sort of our current thinking right now.
Okay. That's great. And, you know, maybe we can segue into sort of capacity situation in the industry, right? I mean, last year, I think we saw in the middle of the year, Yellow, going bankrupt. You know, over the last 12 months or so, we have seen some more bankruptcies, you know, in bigger places like California, Florida, etc. Is capacity coming down rationally in the marketplace, you think? I mean, like, we have seen truck orders kind of, you know, softening now, sequentially at least. What do you think about the capacity situation, or do we need to address the capacity a little bit more from here?
So capacity is coming out of the system, not at the rate that it needs to, though. And I think that's been pretty consistent over the last couple of years. But one noticeable trend over the last 12 months in particular is that larger carriers have been going out. So you know, think about carriers with you know, one to 500 power units, where ultimately, in some cases, some of those carriers have been around for 100-plus years. So I think that just speaks to how soft this freight environment has been and how difficult it's been for some of the carriers that are out there. So capacity has come out.
I think the composition of those carrier exits has certainly changed from, you know, when you think about the initial part of the downturn. It was more smaller owner operators, and then it's migrated towards some of the larger fleet sizes, but I do think more needs to come out. I do think it's a good point that Class 8 orders have come down recently, so I think, you know, as you think about capacity that's come out, still too much in the system, but the trajectory is encouraging in terms of capacity that has come out, but it's still too much relative to end demand.
Okay. That's fair, so let's talk about, you know, the micro factors, you know, like, what can you control right now, so I think cost rationalization has been a theme lately, right, for you guys. And this is even before I'm talking, you know, Coyote's integration, so tell us about, you know, the cost rationalization. What have you done there? You know, what are the opportunities in that space?
So we operate with a continuous improvement mindset. And, when we look at the actions that we've taken over the last two years post-spin, this is pre-Coyote, to your point, we've taken out over $65 million of annualized costs out of the model. So when the way we're thinking about the business is, how are we priming the operating model for incremental margin leverage from here to ensure that the costs that are coming out are largely structural? And when we think about what those contribution margins are going forward, when the market does recover, that they'll be quite strong. I mean, when you think about our brokerage business, you know, for every dollar of incremental gross profit that flows through the P&L, you know, depending on volume versus price, you can have strong contributions anywhere between 60%-80% from gross profit down to EBITDA.
And then you layer on the efficiencies that we're taking with respect to Coyote, which I'm sure we'll touch on. We're gonna go ahead and achieve at least $40 million of synergies on the cost side, which is up 60% from our initial estimate just a few months ago. And that excludes any benefit that we'll see on cost of purchase transportation, which we think when we combine the two pools of transportation dollars across the enterprises, that has the potential to be the largest source of synergy. So we're operating with this continuous improvement mindset. We are ensuring that the actions we're taking are structural in nature. So when the market does recover, and it will recover, the question is when, not if, the operating margin flow-through and subsequent free cash flow generation will be pretty powerful.
Okay. You know, like, in the brokerage business, you know, the software is one thing that sets you apart, right? I mean, like, we have seen and, you know, companies come and go, like Uber Freight, etc., in terms of your software platform, how does it set you apart from your competitors? You know, any competitive advantages you see there? Any evolution of that software? Like, what's required? What's a new tech like?
One of the key benefits that RXO is able to leverage is the fact that when we spun post-XPO, we get to leverage the hundreds of millions of dollars that were spent building RXO Connect, which is our platform, over the last decade. So having that software ecosystem that really touches three main cohorts, our employees, our carriers, and our customers, and have that cohesive solution that operates at, we think, best-in-class performance across the system, across the ecosystem, I think is really powerful. So, you know, I think about the employee benefits and the ability to drive increased productivity, where last quarter our productivity over the last 12 months was up 15%. So leveraging RXO Connect, being able to make sure that all of those three cohorts have access to that technology.
And we're so comfortable, and so confident that it's such a great technology platform. We've now decided to standardize as it relates to the acquisition of Coyote. We mentioned last week during earnings that we're gonna go ahead and combine the two platforms onto RXO Connect. And we're really taking that best-of-both-worlds approach. I think there was a lot of great features within Bazooka, which is the old Coyote transportation management system. We're gonna integrate that into RXO Connect. And we're gonna have what we believe will be the best operating system that's out there. And our customers and our carriers and our employees will get to benefit from. And before we move on, I just wanna emphasize one point. The technology investment's critical, but the way we fundamentally approach the business is that it's a combination of technology and our people. The technology's great.
It's critical to ensure that we're driving efficiency. We're providing that service that our customers would expect and require. But if you don't have the best operators behind the scenes, you know, it's only gonna get you so far. So we're talking about individuals that have been in the freight industry for the last 20, 30 years that have seen every freight cycle, know how to respond in changing environments, know how to deliver for our customers. So I think it's a really powerful combination between technology and people.
Right. I think technology's the way to go. Let's talk about Coyote a little bit. You know, I know you mentioned about, you know, the synergies, ramping up on that, pretty early on as well. But just taking a step back, what got you into Coyote? You know, like, why was that acquisition so important for RXO?
So it was a transformative acquisition that effectively doubled the size of our brokerage business. And the benefits to scale in truck brokerage are enormous. The ability to invest through cycle to ensure that you're providing, you know, the best service, the best technology solutions to your customers. And you think about the ability to take all of the legacy Coyote volume, put it onto our platform, and truly get to benefit from scale. Because when you think about it, you know, from a brokerage P&L standpoint, after you get through, on the P&L post from gross margin, right, the key operating costs are people, technology, and real estate, right? Those are largely fixed. So adding more volume and getting to benefit from that power of scale, I think, is really important. And I think, so that was part of the strategic merits of the deal.
And then, we got even more excited when all of the diligence came to the conclusion that there was minimal customer overlap and minimal carrier overlap. So, you know, when you think about a brokerage M&A deal, you wanna ensure that there's minimal overlap on both of those. And from a customer standpoint, legacy Coyote served small to medium customers, mid-sized customers, were heavy in the transportation and food and beverage verticals. And then you contrast that with legacy RXO, which had exposure in retail, e-commerce, industrial, dealing with a lot of the small owner operators between one and 10 trucks as part of their fleet, really complementary in nature. So a scaled-up acquisition that's highly complementary, and then certainly check the box of being materially accretive to both adjusted free cash flow and adjusted earnings.
Importantly, as part of this transformative deal, we're able to go ahead and reduce our leverage by more than 40% as a result of the successful financing, given how strong the demand was from the investment community. Our leverage now is sitting at 1.6 times, trailing 12 months combined, which is right in the middle of our target of 1-2 times longer term at the bottom of the cycle. So a lot of optionality on the balance sheet.
That's great. You know, you talked about the scale benefits that you got from Coyote, right? But was there any other benefit in terms of, you know, expanding your end markets or getting into new end markets where you were not before in terms of complements?
Yep. Food and beverage and transportation, two key end markets that we increased our exposure to. We more than doubled the size of our LTL offerings as it relates to that service offering. On the Coyote LTL side, it was also more SMB versus the traditional legacy RXO LTL offering that was more enterprise in nature. Highly complementary. Coyote had a very nice intermodal business where RXO was subscale. I think the intermodal complementary offering would be nice, or will be nice. I think the you know, when we look at the immediate benefits that we're already seeing on the synergy side, this was not something we were counting on on the top line. We've already identified more than 200 unique cross-selling opportunities, cross-selling legacy RXO services into that legacy Coyote customer base.
I think long-term on the managed transportation side, being able to go ahead and, because of the increase in diversity with respect to vertical exposure, if you think about RXO's managed transportation business, that's more automotive, industrial. So being able then to go ahead and take the expertise that Coyote has within a vertical such as food and beverage, and then, it's a long lead time, you know, sometimes as much as 12-18 months, but then go ahead and engage in those kind of cross-selling opportunities on managed transportation, I think that's pretty significant. The other thing I'd mention is on the carrier side, I think we alluded to this earlier, we're already tapping into Coyote capacity in a pretty effective manner. We're not gonna enjoy the true benefits of cost of purchased transportation savings until we're on one platform, late next year.
But if you think about even in the month of October for some of those relief loads that we saw from the hurricane, we successfully leveraged those loads which were awarded to legacy RXO with that legacy Coyote capacity on some of the larger fleets. So, the benefits to scale and the complementary nature of the businesses are already showing.
Okay. It's just a few months in, right, the Coyote, and it's already kind of showing the fruits here. But, any more surprises you're anticipating on the Coyote side? I mean, like, you know, I think once it's all said and done in terms of synergies on both revenue side and cost side, you know, what does the pro forma business look like? You know, are you anticipating any more incremental kind of juice you can extract from that?
Sure. So, our initial synergy target on the cost side was at least $25 million. We increased that last week to at least $40 million after owning the business for less than two months, with an emphasis on at least, right? We think that when we look at the opportunities for vendor spends, technology spends, duplicative roles, and the ability to go ahead and then spend more effectively or purchase transportation more effectively, that's on top of the $40 million of cost synergies, which I mentioned earlier, we think could be the largest source of synergies. So, you know, when we think about the pro forma earnings power for this business, we think it is materially higher from here. And we think we're gonna successfully buy down that Coyote multiple, which we think was, you know, trough on trough.
We're very pleased being able to double down on brokerage at the bottom of the cycle. We're gonna buy down that multiple even further with the synergies that I just talked about.
Okay. That's great. I think, you know, like, the market clearly liked the deal, right? And so your stocks turned extremely well. How about the customer reaction to that? You know, like, do customers appreciate these kind of things, you know, when you're such a large player in the industry? Or are they kind of concerned that now you're more powerful, so, you know, like, it becomes more contentious?
Customer reaction has been overwhelmingly positive, and when you think about if you're a tier one shipper, you know, Coyote was put up for sale, and there was this interim time period in terms of not knowing where that business was gonna land. So now that RXO is the home for that asset, I think there's a sense of relief in terms of unclear where it was gonna go. And it's going into a 3PL that this is what we do, right? So transformational acquisition for us, but dealing with tier one shippers, and servicing that customer freight, is what we've been doing for the last 15 years. So the customer conversations have been overwhelmingly positive.
They understand the benefits that we're talking about here today in terms of access to more capacity, access to more service offerings, them getting to benefit from the increased scale and purchase transportation. I think it's been incredibly positive so far.
Okay. That's great. And, you know, like, when you do these kind of transformative acquisitions, right, obviously the industry takes notice, right? Has it kind of triggered conversations in the industry? You know, are your competitors kind of now looking to scale up as well?
Yeah. I can't speak to what our competitors may or may not do, but you know, it is a very fragmented industry, right? It is a $400 billion for-hire truckload market, and within that, brokerage represents about, call it $80 billion-$90 billion. And then within that brokerage space, you know, the top nine players post-Coyote acquisition represent about 50% of the market, right? So there's a tremendous amount of fragmentation within the market. We've been saying this for a while. We think that the top 10 players likely represent a higher percentage of the market longer term because you need scale in this business for all the benefits, for all the reasons we just talked about, so we certainly think that there'll be more consolidation going forward.
We've talked about how, you know, post-Coyote, we now have a scaled platform, and M&A is part of our growth algorithm. We certainly have a balance sheet that has incremental capacity. We're gonna get the execution of Coyote right. We're gonna integrate it well. But I do think that we have, we certainly have the balance sheet capacity and the skill set on behalf of a management team that's integrated and acquired, you know, a dozen plus companies in their past, to go ahead and execute on more M&A going forward.
Sounds like you're not done on the M&A side yet here.
We think it's compelling as part of the growth algorithm. If you think about our earnings power longer term, right now we're at cyclical lows as it relates to gross profit based on being in the longest freight recession on record. Combine that with increased productivity gains that we're gonna have based on putting on one platform, then layer on the legacy RXO cost initiatives, the cost initiatives associated with Coyote on the synergy side, the cost of purchase transportation benefits, the managed transportation pipeline, and then layering on additional M&A as part of that growth algorithm, we think it's gonna be the best growth algorithm or will be the best growth algorithm in transports.
Okay, and, you know, like, if you look at the portfolio today, right, and, you know, after the integration is done and all that, where would you see the next best opportunity for consolidation in your space? You know, like, would you like to be more active in something similar to Coyote to scale it up further, or is there any some sort of tangential aspects?
I mean, there is a lot that's out there, right? So you just think about RXO and where we have the highest return on invested capital. It's within brokerage and managed transportation. And within brokerage, you think about all of the different asset classes that are out there where we don't have service offerings today, right? Think about reefer, think about LTL, think about flatbed, think about drayage, think about more managed transportation freight under management, right? So by putting more freight under management into the system, we have a very strong relationship with our brokerage business and our managed transportation business where many customers wanna come to RXO managed transportation because they want that dedicated capacity available to them via brokerage.
So the ability to go ahead and put more freight under management from managed transportation into the system can help accelerate our RXO brokerage growth. So, hopefully that gives a little bit more color.
Great. No, thanks. In terms of capital structure, you know, like, what, what's the right balance for you guys? You know, like, I think once the Coyote is integrated, you still have maybe, let's say, an opportunity to organically grow the business here as the markets rebound. Leverage is already kind of pretty low, I would consider. You know, how would you keep it optimal? You know, like, do you consider some sort of shareholder returns or any other opportunities besides, you know, what you're doing right now?
So our capital structure philosophy or capital allocation philosophy, I'd articulate in three different ways. First thing is always invest back into the business. The organic opportunity to capitalize on here is tremendous. And if you look at the growth pre-Coyote over the last 10 years, 90% of it was organic. So that is no stranger to us. And that's what we've been doing for the last 10 years with very strong return on invested capital within the brokerage business. So, invest back into the business, making sure that we have the ability to effectively allocate resources to the company. Secondarily, to your point, in terms of shareholder return, we've got a $125 million share repurchase authorization. So certainly, depending on market conditions, have the ability to repurchase stock. And then three is M&A, right?
So, you know, no better time to invest in the business strategically than at the bottom of the cycle. So we doubled down on brokerage with the acquisition of Coyote, and we continue to believe that M&A will be part of our toolkit as part of that capital allocation philosophy. And our balance sheet capacity for all three of those deployments of capital across organic share repo and M&A is quite strong, being now at 1.6 times leverage last quarter.
Great. And, looking at, like, a couple of years maybe from here, you know, as the market turns, do you think, you know, maybe organic growth opportunity is a little bit bigger than the M&A opportunity, at least in the short or medium term?
I think both are pretty significant. I mean, you think about how fragmented the market is, you think about how large the market is at $400 billion, and the ability to go ahead and capitalize on a lot of these secular trends in terms of managed transportation, potential redomiciling of supply chains and nearshoring, and what that means to the transportation ecosystem in North America, on both sides of the border. I think there's a lot of opportunity to capitalize organically. I think I would characterize the opportunity set across both organic and inorganic as pretty strong.
Okay. You mentioned nearshoring, actually. That's been a pretty close theme at Scotiabank lately. And, you know, I wanted to ask you about how do you kind of play into that theme right now? You know, like, you have broadly U.S. exposure, I believe, right now. Do you need to expand into geographies to capture that? Are you seeing any benefits, you know, in pockets of the U.S. markets?
We have a significant presence on the border of Mexico with a facility in Laredo, Texas, right on the World Trade Bridge, and we have significant operations in Mexico on both legacy Coyote and legacy RXO as well, so we think about the ability for. We do think fundamentally we agree with you that nearshoring, you know, we've, it's been a trend over the last five, 10 years. We think that's a secular trend for the long term. We don't see that slowing down. As you think about redomiciling of supply chains here in North America and having, you know, Mexico now is the United States' largest trade partner, so that relationship is strong, and you think a lot of the companies, especially within the automotive vertical, have really embraced it.
That is, you know, within our managed transportation business, we are the leader in managed expedite in North America. We have got, within our managed transportation business, also that freight forwarding, sorry, that. We have got a freight forwarding business that also serves more domestic-type offerings, such as the facility we have down in Laredo, Texas. We also do customs brokerage as well, transloading. We very much subscribe to the notion that the nearshoring effort is here to stay and likely accelerates longer term.
Okay. And, with that, I guess, like, just final question maybe, what's your take on Trump 2.0? How does it shape out here?
We'll see what policies end up getting implemented, but certainly, I think if the policies have the potential to be a real significant accelerator as it relates to over-the-road trucking, when you think about any type of tax reform as it relates to the corporate level and what that means for increased investments, especially with any kind of increased deregulation given their new Department of Government Efficiency. When you think about any kind of corporate individual tax reform and what that means for individual spending, the redomiciling of supply chains to the extent that tariffs get implemented and you start to see more goods come through North America, I do think that it has the potential. I think there we need to also see some of the implications, especially from a tariff standpoint, to the extent that they are inflationary and they do impact the consumer.
So I think we want, we certainly wanna be balanced, but that's how we're thinking about it right now.
Okay. I think TBD on that maybe. On that note, Jared, thanks so much for the time. Appreciate it.
Perfect. Thank you so much. Thanks for having us. Thank you.
Cheers.
Thank you.