Brokers Cautious On Brambles’ Strategy

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

-Targets are challenging
-Ferguson metrics stretched
-Cost pressures in the US
 

By Eva Brocklehurst

Brokers are watching pallet and container business Brambles ((BXB)) carefully. The company has set itself various targets for returns on invested capital and has updated its earnings guidance for FY15 to include the recent acquisition of container business Ferguson. Brambles now expects 9-12% constant currency growth across its business base in FY15. As macro economic conditions across many of the company's geographies are patchy, concerns centre on the near-term dilution of returns on investment in emerging markets and whether this is being offset by accretion in established businesses.

The update provided the first time the company has presented its strategy since the acquisition of Ferguson. Brambles has stated that it assesses acquisition targets against its organic investment profile and considers whether the acquisition will provide a head start in a new geography or industry vertical. The company is also seeking to redeploy excess cash generated in more mature businesses into more long-dated growth initiatives.

Management is confident regarding the projected returns at Ferguson but Macquarie suspects it will be a challenge, given the significant amount of capital required to be reinvested. Brambles expects Ferguson, consolidated from September 1, will contribute a return on capital employed of around 6.0%. The earnings multiple implied in FY15 by the acquisition is 14 times, which reinforces UBS' view that valuation metrics of the transaction are stretched. Brambles remains confident that value-adding strategies should improve the return on capital employed to 12.0% by FY19.

While Deutsche Bank can find some similar characteristics to the rental model in Brambles' core operations, the broker is yet to be convinced of the strategic imperative surrounding the acquisition of Ferguson. The company has outlined deep water production growth rates of 6.6% from 2010-2025 but Deutsche Bank suspects oil companies are likely to be very price sensitive at present. It is probable that other developments will be given priority. Once an operation is up and running it is less sensitive to daily oil price movements and then containers would likely be rented for long periods of time.

Brambles is looking to leverage customer relationships to move into the Gulf of Mexico, and Brazil on a longer-term horizon. Deutsche Bank notes current estimates for deepwater capex in Brazil through to 2018 account for 33% of global deepwater spending. Hence, the broker believes, on this basis, Brambles should be penetrating Brazil's market sooner.

Morgan Stanley also wants to see return on investment targets met before becoming more bullish, noting management continues to target base business returns of 20% by FY19. The broker believes the company deserves more than its current 6.0% premium to the ASX200 industrials. On the positive side, with capital being recycled in lower returning units like IFCO, CHEP Asia, the automobile and aerospace divisions, targets encouragingly imply significant and accessible expansion in the mature North American and European CHEP businesses. Morgan Stanley is still cautious about Ferguson, as the company's prior acquisitions have missed their targets, albeit in different divisions.

Brambles' valuation remains undemanding, in Morgan Stanley's opinion, given its exposure to growth in emerging markets and first mover advantage. Moreover, the broker considers capital recycling in emerging units is preferable, given the growth profile and expertise, to capital management, although admittedly there are execution risks with the former.

UBS takes a harsh view of the pallets business, noting cost pressures continue and management expects negligible operating margin upside. This reflects an ageing pool that is being worked harder. The US is experiencing inflation in road transport of around 10% which cannot be readily passed onto customers. The broker considers Brambles is a high quality, low risk growth stock but also fully valued and this justifies a Neutral rating. High maintenance capex, in order to replace 8-10% of the pallet pool each year, restrains equity free cash flow yield to only 4.0% and the broker envisages this will limit valuation upside.

FNArena's database contains five Buy ratings and two Hold. The consensus target is $10.02, which signals 4.1% upside to the last share price. Targets range from $9.10 to $10.62.
 

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