Australia | Oct 05 2006
By Greg Peel
“Neither a borrower nor a lender be;
For loan oft loses both itself and friend,
And borrowing dulls the edge of husbandry.”
So said Lord Polonius to Hamlet, but one assumes wise old Lord Polly probably held no shares in a listed Danish transport company with as good as a global monopoly in pallets.
Following the announcement last month that Brambles (BIL) would unify its Australian and UK operations and then re-list on both the ASX and LSE, analysts have been quick to point out that the company is suffering from a lack of debt. A lack of debt so serious that if the board doesn’t keep one eye open it will wake up one morning taken over.
About three weeks ago, when the Coles rumour mill was in full swing, Merrill Lynch analysts suggested a private equity firm such as KKR might be ready to have a good look at Brambles. Merrills believes Brambles is undervalued if for no other reason than the accounting method used for CHEP overstates, in the analysts’ opinion, depreciation, meaning earnings could be underestimated by 5-15%.
The other reason was that post unification, Brambles would be severely under-geared. At the time, the stock was trading at $12.08 and the analysts thought a bid of $15.00 would be credible. They did not, however, believe the board would roll over at that price.
Here we are three weeks later, and the rumour mill has been at it again. Brambles is $1.00 higher based largely on news coming out of the UK last week. The Independent tipped Wesfarmers (WES) as a buyer at 600p ($15.25), while Reuters had General Electric in the frame, also at 600p.
While the stock price has rallied locally, it has not been quite a Coles affair. The market is still some $2.00 below the rumoured prices. In terms of the plausibility of a bid, a couple more brokers have weighed into the argument.
Last Friday Macquarie suggested a suitor could pay $15.00 (a 17% premium) for an internal rate of return of 15%. This would put Brambles at 13.4x FY07 and that’s a 50% premium to the industrials, but Macquarie suggests CHEP should be seen more as an infrastructure business given its competitive advantage and high barriers to entry.
Macquarie had earlier set a target price of $13.20, and as the stock nears that level it would be normal for the analysts to pull the Outperform rating in to Neutral, but given the possibility of a takeover bid, Macquarie has decided to retain both target and rating.
JP Morgan has carefully analysed the situation in a report released this morning. The analysts decided that Brambles could not be realistically taken over for anything less than $18.00.
That puts things into a different perspective. (And probably gives Brambles’ board weight of argument to reject anything else).
Both the JP Morgan Brambles analysts and the Wesfarmers analysts agree that WES is an unlikely contender. It would not pay $18.00, they have little in common, Brambles is not a typical “unloved” company favoured as targets by Wesfarmers, and Brambles shareholders are hardly likely to accept scrip in a diversified industrial as reward.
GE, on the other hand, is a credible contender, JP Morgan believes. A decade ago GE became interested in pallets and tried to take CHEP on in its home market by creating Loscam. It failed. Pallet rental is just too entrenched a market and the only way to win, including in the US market, would be to buy CHEP. And the only way to buy CHEP is to buy Brambles.
Morgans believes the “collapsing” of the dual-listing provides the first real opportunity for Brambles to be taken over since the GKN merger. One of the reasons is the company’s extremely low debt levels. If Brambles is going to defend itself then Morgans suggests it borrows with its ears pinned back.
The analysts believe Brambles could borrow $2.5bn over the next 12 months, still pay out $2.50 in special dividends and maintain about 5 times interest cover. Without re-gearing, Morgans suggests dividend payments could rise from 25c now to 43c by FY10.
As a result of their analysis, the analysts have increased their discounted cash flow valuation from $13.38 to $15.90, raising the price target to $15.67. This puts JP Morgan way ahead of the pack (a position JP Morgan analysts often feel comfortable with), 19% ahead of the FNA database average at $13.12 and 12% ahead of nearest rival Credit Suisse at $14.00. The database currently shows a 7/2/1 ratio (B/H/S).