S&P Upgrades XPO Logistics (XPO) to 'B+'; Outlook is Positive

August 23, 2016 2:41 PM EDT

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S&P Global Ratings today raised its corporate credit rating on XPO Logistics Inc. (NYSE: XPO) to 'B+' from 'B'. The outlook is positive.

At the same time, we raised our issue-level rating on the company's senior secured credit facility to 'BB' from 'BB-'. The recovery rating remains '1', indicating our expectation for substantial recovery (90%-100%) in a payment default scenario.

We also raised our issue-level ratings on the company's unsecured notes due 2019, 2021, 2022, and 2023 to 'B' from 'B-'. The recovery rating remains '5', indicating our expectation for modest (10%-30%; upper half of the range) recovery in the event of a payment default.

We also raised our issue-level rating on the company's senior unsecured notes due 2018 and senior unsecured debenture due 2034 to 'B-' from 'CCC+'. The recovery rating remains '6', indicating our expectation for negligible (0%-10%) recovery in the event of a payment default.

"The upgrade of XPO reflects the strengthening of the company's credit metrics, resulting from acquisition–related earnings growth and cost synergies and our expectation that credit ratios will continue to improve over the next year as earnings climb and cash flow generation strengthens," S&P Global Ratings analyst Tatiana Kleiman said.

As of June 31, 2016, XPO's trailing-12-month funds from operations (FFO)-to-debt ratio rose to 10% from 2% and its debt-to-EBITDA metric dropped to 6.2x from 21.1x, as of the same time last year. Over the next 12 to 18 months, we expect the company to maintain this upward momentum in operating performance, cash flow, and earnings generation, supported by acquisition contributions and synergies, a focus on operating costs, price increases, and productivity improvements resulting from information technology (IT) enhancements and other organizational initiatives. We believe this will result in FFO to debt increasing to the low-double-digit percent area by 2017 and debt to EBITDA improving to the 3.0x-3.5x area. We assess XPO's financial risk profile as aggressive, an improvement from our previous assessment of highly leveraged.

The outlook on XPO is positive. The company has grown rapidly over the past few years, most recently because of the acquisitions of Norbert Dentressangle and Con-way, but because of favorable dynamics in its last mile, LTL, and e-commerce businesses. Over the past year, XPO has also focused on improving its operating efficiency and earnings, the effects of which were evident in the company's positive free cash flow generation for the second quarter of 2016. We expect XPO to continue to expand its revenues and improve its earnings such that debt to EBITDA would decline to the mid- to high-4x area and FFO to debt to improves to the mid-teens percent area by the end of 2016.

We could upgrade the company over the next year if it continues to demonstrate revenue growth and EBIT margin expansion, maintains positive operating cash flow generation, and refrains from engaging in large debt-financed acquisitions, such that its EBIT margins increase to above 7.5% and remain there on a sustained basis. This could also happen if its FFO-to-debt ratio improves to the high-teens-percent area and debt-to-EBITDA declines to the low-4x area.

We could revise the outlook to stable if XPO's FFO-to-debt ratio fails to improve as expected, such that it remains in the low- to mid-teens-percentage area, which could occur if XPO does not moderate its aggressive pursuit of acquisitions as we expect.

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