Transport stocks pullback brings buying opportunity? Citi bullish on industry cycle improvement, upgrades XPO (XPO.US) rating to "Buy".

Citi Research believes that the recent broad pullback in the U.S. transportation sector has made freight stocks attractive again on valuation. Analyst Ariel Rosa has therefore turned more optimistic on the industry outlook and upgraded less-than-truckload (LTL) company XPO (XPO.US) from "Neutral" to "Buy," while also expecting the company to post strong third-quarter results. Last month, JB Hunt Carriage Services Inc. (JBHT.US) issued a profit warning, triggering a broad selloff in the freight sector. Rosa believes this round of adjustment drove the entire transportation sector through a "valuation reset," which is a relatively healthy correction and has created a more attractive entry opportunity for investors. Although macro risks such as high fuel prices and rising interest rates may still keep the market cautious, the decline in sector valuations has reopened potential upside. Rosa noted that macroeconomic downside risks have increased somewhat in recent months, but the transportation industry cycle is still expected to continue improving. As industry capacity tightens further, contract transportation prices are expected to see more room for increases through 2027, which will support the earnings performance of related companies. Against this backdrop, Citi named C.H. Robinson (CHRW.US), Saia (SAIA.US), TFI International (TFII.US), GXO Logistics (GXO.US), and XPOwhich was upgraded to "Buy" in this instanceas top picks in the sector, while also favoring United Parcel Service (UPS.US) and FedEx Corporation (FDX.US). For XPO's upcoming third-quarter results, Rosa expects the company to record mid-single-digit percentage growth in freight tonnage, while higher fuel surcharges are expected to support earnings before interest and taxes (EBIT). In addition, XPO's current pricing environment remains favorable and is expected to improve further in the fourth quarter. Citi estimates that about half of XPO's third-quarter yield growth will come from core pricing improvement, with the other half from business mix optimization. As the company continues to expand key businesses such as local transport, premium services, and grocery customers, its 13-percentage-point gap with industry leader Old Dominion on relevant yield metrics is expected to narrow further. Rosa said XPO continues to benefit from relatively healthy market demand while continuing to gain market share. Among LTL peers, the company's freight volume and price growth are both expected to exceed the industry average, which has also become an important basis for Citi's rating upgrade. Cash flow improvement is also part of the XPO investment thesis. Citi expects XPO's free cash flow to double year over year to about $800 million this year and reach $1 billion in 2027. As its cash generation capacity strengthens, the company may further expand share buybacks in the future. XPO plans to report third-quarter results before the U.S. market opens on October 29. The market currently expects quarterly revenue of about $2.37 billion and adjusted earnings per share of $1.57. Currently, Wall Street analysts and the U.S. investment research and financial news platform Seeking Alpha both have a consensus rating of "Buy" on XPO, and Seeking Alpha's quantitative rating is also "Buy," with a score of 4.31 out of 5. Overall, Citi believes that after the recent valuation pullback, if the trends of transportation industry cycle improvement, capacity tightening, and contract price increases continue, the risk-reward profile of freight stocks such as XPO has improved significantly from before.