More Pallets, More Upside For Brambles

This story features BRAMBLES LIMITED. For more info SHARE ANALYSIS: BXB

As restaurants close to stop the spread of coronavirus there is more demand for supermarket food, beverages and fresh produce and Brambles is one of the less obvious beneficiaries.

-Fast asset turnarounds could provide to US$160m in additional cash
-Extent of cost reductions from economic slowdown unclear
-Has Brambles overshot the downside?
 

By Eva Brocklehurst

Brambles ((BXB)) is one of the less obvious beneficiaries of the increased demand for supermarket food as a result of the coronavirus crisis. Moreover, it has high exposure to North America and Western Europe, now the two hotspots in the outbreak.

This is not to suggest the business is without risk, with the crisis affecting the safety of employees amid disruptions to logistics from chaotic demand/supply conditions along with higher competition.

Nevertheless, as restaurants and cafes are closed to stop the spread of coronavirus there is increased purchasing of packaged food, fresh produce and beverages through supermarket channels as large numbers of people are forced to eat at home.

Brambles generates around 80% of revenue from producers of packaged/fresh food, beverages and other items defined as fast moving consumer goods. This should offset softer revenue in automotive containers, less than 4% of revenue on Credit Suisse's estimates, and other cyclical exposures.

The main consideration for investors needs to be the scope, depth and duration of government-imposed lockdowns, in Citi's view, and structural change could be driven by hygiene concerns following the outbreak. The broker points to a study in the New England Journal of Medicine which has indicated the half-life of coronavirus on plastic and wood surfaces is 4-5 days.

Still, fast asset turnarounds could provide Brambles with up to US$160m in additional cash flow in FY20 and the replacement rate could be pushed lower as assets are return more quickly and there is less damage or pallet losses likely.

Another interesting statistic: on the broker's calculations Brambles spent US$460m replacing lost, broken or poor-quality pallets across the major CHEP Americas division in FY19. Citi also estimates, for every 1% improvement in the CHEP Americas replacement rate, Brambles generates US$40m in additional cash flow.

Morgan Stanley has feedback that suggests pallet poolers are meeting elevated activity with increased velocity, although this comes with handling and transport costs. Morgan Stanley notes revenue for the business was resilient through the GFC while margins were volatile.

Costs

This partly reflected an increase in plant costs, which tend to occur during a slowdown. The starting point for margins heading into the GFC was higher than today's level, although there is currently price momentum and efficiency initiatives that should contribute. All up, the broker considers the risks to margins balanced.

Margins in the Americas have been affected in recent years by high cost inflation but Credit Suisse expects the economic slowdown will significantly reduce these costs for some time. The broker assesses the Americas earnings (EBIT) margin will hit 18.5% in FY21, up from 14.3% in FY20.

The balance sheet is strong and there is US$2.4bn in liquidity with no material refinancing in the medium term. Credit Suisse upgrades to Outperform, although remains cautious about the weak and volatile Australian dollar rate.

When the crisis has passed and demand has reduced through supermarket channels, FY22 is expected to show low revenue growth. The broker increases constant FX revenue growth estimates for FY20 to 7.4% and expects this will slow to 3% in FY22.

Sell-Off Overdone?

There is also the ongoing buyback. Along with a medium-term defensiveness and leverage to a weaker Australian dollar, Morgan Stanley considers this is at odds with the recent performance of the share price. Brambles has outperformed the market over the past three months but not to the same extent as those that have participated in "essentials" supply and Morgan Stanley, too, upgrades to Overweight.

Citi notes that, while the buyback is still underway, Brambles is likely to be entering a "black-out" period ahead of the third quarter sales update and investors should be mindful that the buyback will pause over this time. The broker agrees valuation support has emerged, although there is a high level uncertainty around the outlook, and the extent to which the share price has overshot on the downside is unclear.

Management has guided to mid-single digit growth in revenue and underlying earnings but this could be difficult to maintain in the current environment and Citi does not expect it will be that easy for the CHEP business in the second half.

FNArena's database has three Buy ratings and three Hold. The consensus target is $12.58, suggesting 19.1% upside to the last share price. The dividend yield on FY20 and FY21 forecasts is 4.1%.

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