The past six months have been a windfall for RXO’s shareholders. The company’s stock price has jumped 73.7%, hitting $28.25 per share. This was partly thanks to its solid quarterly results, and the run-up might have investors contemplating their next move.
Is there a buying opportunity in RXO, or does it present a risk to your portfolio? Get the full stock story straight from our expert analysts, it’s free.
Why Do We Think RXO Will Underperform?
Despite the momentum, we don’t have much confidence in RXO. Here are three reasons you should be careful with RXO, plus one stock we’d rather own.
1. Demand Slips as Sales Volumes Slide
Revenue growth can be broken down into changes in price and volume (the number of units sold). While both are important, volume is the lifeblood of a successful Ground Transportation company because there’s a ceiling to what customers will pay.
Over the last two years, RXO’s units sold averaged 2.5% year-on-year declines. This performance was underwhelming and implies there may be increasing competition or market saturation. It also suggests RXO might have to lower prices or invest in product improvements to grow, factors that can hinder near-term profitability. 
2. Free Cash Flow Margin Dropping
If you’ve followed StockStory for a while, you know we emphasize free cash flow. Why, you ask? We believe that in the end, cash is king, and you can’t use accounting profits to pay the bills.
As you can see below, RXO’s margin dropped by 5.3 percentage points over the last five years. Almost any movement in the wrong direction is undesirable because of its already low cash conversion. If the trend continues, it could signal it’s in the middle of a big investment cycle. RXO’s free cash flow margin for the trailing 12 months was negative 1.2%.
3. Short Cash Runway Exposes Shareholders to Potential Dilution
As long-term investors, the risk we care about most is the permanent loss of capital, which can happen when a company goes bankrupt or raises money from a disadvantaged position. This is separate from short-term stock price volatility, something we are much less bothered by.
RXO burned through $75 million of cash over the last year, and its $728 million of debt exceeds the $15 million of cash on its balance sheet. This is a deal breaker for us because indebted loss-making companies spell trouble.
Unless the RXO’s fundamentals change quickly, it might find itself in a position where it must raise capital from investors to continue operating. Whether that would be favorable is unclear because dilution is a headwind for shareholder returns.
We remain cautious of RXO until it generates consistent free cash flow or any of its announced financing plans materialize on its balance sheet.
Final Judgment
We see the value of companies helping their customers, but in the case of RXO, we’re out. Following the recent rally, the stock trades at 84× forward P/E (or $28.25 per share). This valuation tells us a lot of optimism is priced in - we think there are better stocks to buy right now. Let us point you toward a top digital advertising platform riding the creator economy.
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