Investors Taking Gloomy View On Brambles

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

By Chris Shaw

Since the company announced last week its CHEP pallet operations in the US had lost the Pepsi contract to a competitor offering plastic pallets, Brambles ((BXB)) shares have been under pressure and in the view of Macquarie there is scope for additional contract losses as plastic pallets are gaining increased market share.

The broker points out competitor iGPS appears to have the financial capacity to continue targeting CHEP customers as reports suggest the major shareholders in iGPS are increasing their contributions to the company from around US$350 million to closer to US$500 million.

Having the financial flexibility to compete is one thing but as the broker notes iGPS is also lifting the pressure due to the fact that plastic pallets offer an attractive alternative given most of CHEP’s pallets are made from wood and this brings into play questions of pallet quality.

As well, the financial downturn is impacting on the capex plans of customers and so reducing their pallet requirements, the broker pointing out Brambles is presently dealing with a surplus of pallets in the US market and this is also limiting returns.

Putting all this together, Macquarie takes the view Brambles shares are likely to continue to struggle in the shorter-term as iGPS wins more customers and so it rates the stock as Underperform with a 12-month price target of $5.47. In contrast, JP Morgan is far more optimistic, suggesting the recent share price weakness overstates the threat of plastic pallets.

The share price reaction has certainly been significant as from trading at around $5.70 per share on March 24th the stock is now below $5.00 per share and has traded below $4.80 in recent sessions.

But as JP Morgan points out, the market is ignoring some good news in focusing on the potential for a competitor to win additional contracts as the company advised the market last week while it had lost the Pepsi contract it had also won some new pallet contracts and these would add around 2% to annual revenues.

JP Morgan has highlighted the extent to which the market is over-reacting, noting the share price weakness of late implies a loss in market capitalisation of around $1 billion. Based on the stock’s current Price/Earnings (P/E) ratio of 9x and assuming a US dollar/Australian dollar exchange rate of US70c this implies the company will lose one-third of annualised CHEP US earnings before interest and tax in coming years.

For such an earnings loss to be reality the broker estimates there would need to be a 7% price cut with no offsetting reduction in costs, annual spending of $100 million or one-off capex of around $2 billion on quality control against current plans of around one-twentieth this amount, along with the loss of around one-third of CHEP US volumes.

With this combination of outcomes seen as unlikely, JP Morgan retains its Overweight rating, setting its price target on the stock at $6.30. The broker is beating something of a lone drum at present as the FNArena database shows a total of one Buy, five Holds and Underperform four times with an average price target of $6.28. This is distorted to some extent by the Credit Suisse target of $8.10, which dates back to last October.

Shares in Brambles today are slightly firmer and as at 12.00pm the stock was up 12c at $4.92. This compares to a trading range over the past 12 months of $4.78 to more than $10.00.

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