Citi Research believes 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 Logistics (XPO) from Neutral to Buy, while also expecting the company to deliver strong third-quarter results.

Last month, J.B. Hunt Transport Services (JBHT) issued a profit warning that triggered a sector-wide decline in freight stocks. Rosa views this correction as a "valuation reset" across the transportation sector, describing it as a relatively healthy adjustment that has created more attractive entry points for investors. Although macro risks such as elevated fuel prices and rising interest rates may keep the market cautious, the pullback in sector valuations has reopened potential upside.

Rosa noted that macroeconomic downside risks have increased in recent months, but the transportation industry cycle is still expected to continue improving. As industry capacity tightens further, contract freight rates are expected to gain more room for increases through 2027, which would support the earnings performance of related companies.

Against this backdrop, Citi named C.H. Robinson Worldwide (CHRW), Saia (SAIA), TFI International (TFII), GXO Logistics (GXO) and the newly upgraded XPO Logistics as its top picks in the sector, while also expressing a favorable view on United Parcel Service (UPS) and FedEx (FDX).

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 related yield metrics is expected to narrow further.

Rosa said XPO continues to benefit from relatively healthy market demand while steadily gaining market share. Among its LTL peers, the company's volume and price growth are both expected to exceed the industry average, which serves as an important basis for Citi's upgrade.

Improving cash flow is also part of the XPO investment case. 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. At present, 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 quant rating is also Buy with a score of 4.31 out of 5.

Overall, in Citi's view, after the recent valuation pullback, the risk-reward profile of freight stocks such as XPO has improved markedly from before, provided that the trends of an improving transportation cycle, tightening capacity and rising contract prices continue.