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Traxion (GRPOF) is one of the names I analyzed in my Mexico Industrials post, and is a great example of how capital returns determine future growth potential. ROIC vs Debt-Yield in action.
The company markets itself as a tech-enabled logistics company but it actually is a much less fancy business: a roll-up play of logistics companies, like cargo, transport personnel, warehousing, last mile, and brokerage.
All of these businesses have extreme competitive characteristics (atomized sellers, powerful buyers, zero barriers to entry and exit, commoditized offering, low tangible capital returns), which generally implies low returns over the cycle. I believe this dynamic has been muted in the recent past because of the impressive manufacturing boom in Mexico, making for a sellers’ market.
Still, despite the boom, Traxion’s returns on invested capital are very low, maybe around 7% pre-tax (and after adding back D&A). A business with low returns on capital cannot grow organically very fast for the simple reason that it cannot reproduce capital fast enough (the reinvested earnings are a function of ROIC anyway).
So far, so good; Traxion could be a low-growth, low-moat, low-margin business, like many in the stock market. However, in order to post growth and continue the ‘roll-up play’ the company has increasingly taken debt. Not a lot in percentage terms, about a third of its balance sheet.
The problem is that Mexico’s interest rates are above 10%, already a few notches above Traxion’s EBITDA capital returns. This means that before adding too much debt, Traxion is already close to surpassing operating income with interest expenses, and this considering the backdrop of a booming (but cyclical) demand landscape.
Traxion’s bear thesis is, therefore, simple. The company trades at a P/E of 20x because it has been growing at a 10% CAGR. However, it cannot continue growing at that rate organically, and it cannot continue growing at that rate inorganically (via debt) because it is already close to interest coverage. In addition, if there’s a mid-fluke in the logistics market in Mexico, Traxion is severely exposed operationally and financially.
