Treasure Chest | Apr 29 2013
– Brambles' core business steady
– Non-core Recall business is rife for a de-merger
– De-merged entities tend to outperform
By Greg Peel
When one thinks of Brambles ((BXB)), one thinks of CHEP pallets, both in Australia and the US. Brambles is fundamentally a supplier of reusable pallets and other crates and containers under the CHEP and IFCO brands for the purpose of transporting a wide range of goods. But also within the Brambles stable is the Recall business, which specialises in information service management, that is data storage, retrieval, digitisation and so forth.
While physical handling of goods and digital handling of information might have some parallels, Brambles pallet and Recall businesses are effectively stand-alone.
Last week Brambles provided a market update on its March quarter operating performance. Brokers found the results mostly “credible” and largely in line with expectations. The company boasted a 6% increase in pallet sales but the benefits were offset by weakness in other containers, and 5% fall in sales for Recall. JP Morgan summed up the mood by suggesting that lower Recall sales are not a major concern given the business is “non-core” compared to the core pallet business.
Management maintained its FY13 profit guidance, and Macquarie echoed the views of others by suggesting that despite challenges in some areas of the Brambles conglomerate, investors could look forward to reliable operating returns. Macquarie is one of four brokers in the FNArena database with a Buy or equivalent rating on BXB, with two brokers on Hold. Valuation is an issue given a decent share price performance of late, which is cited by CIMB as the reason for the broker’s lone Sell rating.
The FNArena database shows a consensus price target of $9.02, which suggests 4% upside from the latest trading price.
UBS has a Neutral rating on Brambles. In the wake of the company’s quarterly update, the analysts at UBS have decided a de-merger of the Recall business is looking increasingly likely in the near term. Taking forward earnings forecasts and debt levels into account, UBS suggests a valuation for Recall of $1.5bn. However the nature of Recall’s business, being 70% recurring revenues storage fees and high cash flow generation, sets Recall up to be a likely “yield stock”, assuming attractive dividends alongside the defensiveness of recurring cash flows. Given just how hungry the market is for yield stocks at present, both in Australia and overseas, UBS suggests Recall could be valued by the market at better than $1.5bn, which would otherwise see the de-merged company enter the ASX 200 at around the 100 mark.
Recall’s only larger global peer is US-based Iron Mountain, UBS notes, but that company differs in being a more significant owner of property and running a much higher gearing ratio. Iron Mountain is effectively transforming into a REIT, which leaves Recall as arguably the largest information management service provider.
Brambles management could opt to simply sell off Recall to a willing buyer and use the funds to invest in more aggressive growth in its core business, but UBS does not expect this route to be taken. As it sits, the underlying business is comfortably providing funds for an elevated level of capex and a 60% payout ratio on dividends, the analysts note.
Hence UBS suggests an in specie distribution of Recall shares to existing Brambles shareholders is the most likely outcome. In specie de-mergers offer tax rollover relief and carry less execution risk than a trade sale or IPO, and cost less than a trade sale, although the analysts note around $15m would need to be spent to establish Recall as a corporation in its own right.
Should Brambles shareholders be excited by a Recall de-merger?
UBS has analysed nineteen Australian de-mergers executed since 1997 and found that on average the de-merged entity outperformed the market by 18% in the first year and 28% after two years. A relevant case study is offered by Orica’s mid-2010 de-merger of DuluxGroup. In the first twelve months, Orica and Dulux combined outperformed the market by 10%, and since mid-2011 Dulux has risen 70% to the market’s 10%.
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