US Margins The Key Driver For Brambles

Australia | Apr 18 2019

Sales growth for the Brambles' CHEP business reflected strong price realisation and customer expansion in the US, but the critical issue for brokers is easing cost inflation.

-Rising input costs for pallets expected to moderate
-More certainty around the outlook likely to underpin valuation premium
-US margins considered a key driver of the share price

 

By Eva Brocklehurst

Visibility on the outlook for Brambles ((BXB)) continues to clear. Sales growth in the March quarter was driven by an increase in volume and price realisation. Sales for CHEP Americas rose 6% while EMEA (Europe, Middle East, Africa) rose 8% and Asia-Pacific 4%. This was broadly consistent with growth rates achieved in the first half and reflected strong price realisation and customer expansion in the US, Canada and Latin America.

The US$2.5bn sale of IFCO is due to close at the end of FY19 and the company is planning to return up to US$1.95bn to shareholders through a special dividend and on-market buyback.

Brambles has simplified its business to just CHEP pallets, which is defensive and expected to perform well in challenging macro economic conditions. Structural challenges have been superseded by rising input costs but now these are moderating and UBS expects above-trend growth over the next three years.

Nevertheless, Citi urges vigilance regarding further downside to volume growth, as inflation headwinds recede and competitive tension returns. The broker is taking the progress on installations as a critical sign of management's confidence in the automation program, in order to deliver the savings that have been projected from FY20.

Citi expects Brambles can capture 80% of the benefits from automation, given the rational industry structure and the benefit that will be shared with customers.

Cost Inflation

Citi envisages catalysts over the next 12 months are moderating cost inflation in US pallets and the completion of the IFCO transaction. There is more certainty around the key drivers of the stock, including the share buyback and special dividend.  As a result, the broker believes the market is likely to ascribe a valuation premium to Brambles above its historical average of around 20% relative to the ASX 200 ex-resources.

Through the combination of lower cost inflation, automation of the US pallets business and procurement savings, Citi anticipates around 200 basis points of margin uplift for earnings (EBIT) out to FY22. The broker assesses the market is yet to fully factor in the savings, despite the visibility on the outlook improving. On the other hand, the trading update was largely in line and Morgans continues to believe the stock is fully valued.

Spot transport and lumber costs are declining after being up more than 35% in the middle of 2018 and UBS now suspects the peak of cost inflation has passed and there should be a material positive upswing for earnings in FY20.

Margins

UBS has analysis that shows 84% of respondents rate the company's US margin as one of the most important drivers of the share price. Underpinning this, industry data shows pallet rental prices are rising around 10% and new whitewood pallet prices are currently up 14%.

The broker forecasts an earnings margin of 19% by FY22. Deutsche Bank disagrees with this assessment and continues to believe there is a risk that margins ease back in FY20, amid currency headwinds.

Near-term the margin accretion from automation is likely to be modest, at just around 18 basis points in FY19 but Citi then expects this run rate to rise considerably as the savings start to flow. However, the recovery in margins in CHEP EMEA could be delayed, the broker acknowledges. Cost inflation in EMEA is still expected to moderate, consistent with the Americas, but the rate of recovery is likely to be more subdued.

FNArena's database shows four Buy ratings and four Hold. The consensus target is $12.17, suggesting 1.4% upside to the last share price. This compares with $11.76 ahead of the update.

See also, Brambles Treats Shareholders With IFCO Sale on February 26, 2019.

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