Brambles Invests To Strengthen Pallets

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Brambles is investing in technology to strengthen its network advantage in the US and meet structural problems head-on.

-Margin improvement to come from price increases and cost savings
-Technology already delivering value in pallet tracking
-Opportunity to expand in relatively under-penetrated US market
 

By Eva Brocklehurst

Cost inflation continues to plague Brambles ((BXB)) and the company has grappled with the issues, outlining a detailed plan for turning around its US business. The company is guiding for second half margins in the Americas to be above the first half (16.2%), albeit below the 19.1% achieved in FY17.

Margin improvement will come from price increases, via transport and lumber surcharges, and cost savings from automation. The company is targeting medium-term revenue growth in the mid single digits, which is in line with estimates, although UBS suspects there is near-term upside from the pricing strategies outlined at the recent investor briefing.

Technology

The broker believes Brambles has met concerns about cost inflation and outlined a clear plan to offset the impact. There is also upside from the investment in digital technology.

Pricing actions, automation and procurement initiatives are expected to generate a 2-3 percentage point improvement in CHEP's US margin over the next three years, a more optimistic outcome than UBS previously assumed. Management is also targeting a reduction in capital intensity by moderating its pooling expenditure to 17% of sales from 19%.

Credit Suisse upgrades to Outperform from Neutral, believing the company has a credible plan to improve value. The broker is impressed with management and believes it can deliver a significant improvement to the business over the next few years.

The broker observes technology investment is already delivering value, as pallet tracking indicates where pallets are being lost, damaged and used without payment. It also enables the company to add value to customers by finding opportunities to reduce their transport and logistics costs. This, in turn, makes customers stick with Brambles and strengthens its market position.

Credit Suisse points out that input cost inflation – labour, lumber and transport – is an even bigger challenge for competitors which typically have much lower margins. In the US market, Brambles has lumber cost related surcharge clauses in 60-70% of its pallet contracts and can be seen to obtain benefit from these surcharges.

Brambles has already automated the European pallet business to around 85% of operations and, Credit Suisse suggests, has proved its worth.

In contrast, the US business is only 20% automated and the company intends to reach 85% within three years. This will require a US$150-160m investment and a four-year pay-back is expected. Management has calculated this should reduce repair costs by -15% and increase capacity by 30%.

Ord Minnett expects growth in European business to be driven by both new and existing customers, while margins could deteriorate slightly because of short-term cost inflation. Transport costs have risen 7% over the past year and the broker believes there are structural reasons why this may be sustainable, more so than many expect.

Still, in the US, there remains a relatively large under-penetrated market and the company has ample opportunity to expand. Ord Minnett expects 2-5% constant currency revenue growth over the medium term but retains lingering suspicions that investors may not be able to separate the short-term cyclical pressures from the long-term structural issues.

Macquarie likes the company's longer-term opportunities but retains concerns about the ability to pass on increase costs, particularly in transport, and maintains a Neutral rating.

In the wake of the first half results, several other brokers, including Morgans and Deutsche Bank, also consider the stock fully valued at current levels.

There are three Buy ratings and four Hold on FNArena's database. The consensus target is $10.45, suggesting 6.4% upside to the last share price. Targets range from $9.60 (Citi) to $12.25 (Ord Minnett).

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