Brokers Sceptical Of Brambles’ Targets

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

–Focus on better quality
-Product customisation
-And retaining pallet customers
 

By Eva Brocklehurst

Pallets and containers business Brambles ((BXB)) remains pre-occupied with the opportunities it can pursue long term – and its earnings targets. Management is confident it can achieve a 20% return by FY19 from the $1.5bn in growth capex to be invested over the next four years and has reiterated FY16 guidance.

Brokers are still wary, noting significant earnings growth is required to justify the investment. Still, there is also a greater focus on protecting the business, UBS observes. This entails better pallet quality, more certainty of supply and a holistic focus on solutions. These strategies may dilute returns in the near term but extend the sustainability of the business and its long term growth potential.

The investor briefing, which took place in California, dwelt on the business in the Americas, which accounted for 47% of sales in FY15. Macquarie suspects the FY19 target will be difficult to achieve as US margin pressure is likely to continue through FY16, despite a valuation tailwind from a weak Australian dollar.

Transport costs are rising in the US. Macquarie was disappointed in that the briefing provided no potential turnaround story or mitigation strategies to counter increased costs. The issue for Brambles, in the broker's opinion, is the timing mismatch in being able to pass on costs through re-pricing customer contracts, of which many are around three years in duration.

Following the acquisition of IFCO, the company's RPC (reusable plastic containers for produce) footprint has been primarily expanded across Europe. Therefore, as the US is the largest market it remains a significant opportunity, with around 86% estimated to be unserved in RPC. Product customisation provides the platform from which Brambles can take share from alternatives.

Even so, the opportunity is not simple. Increased competition and stricter global standards for fresh produce sales are driving some retailers to seek alternative RPC designs to differentiate their display. Macquarie anticipates that the company's approach will remain measured, as scale is ultimately what drive the economics of the business.

Another issue is customer retention in the pallets business, CHEP. CHEP North America has delivered an average of 5.0% constant currency sales growth over the last five years. The broker notes, in a relatively commoditised business, this highlights the strength of the network. Nevertheless, organic volume growth has averaged less than 1.0% over the same period.

With pricing and volume growth largely beyond the company's control, Macquarie welcomes customer retention initiatives although the benefits will be realised only gradually. There is also the opportunity for growth through technical innovation. The economics of tracking pallets remains tough to justify but Macquarie considers it a large opportunity. The main obstacle is the cost of tracking, relative to the low cost of replacing pallets.

Citi likes the focus on investing in quality, not just quantity, and considers the company is taking a more balanced and robust approach in growing its business. In RPC, the move to a wood-look crate for Wal-Mart has triggered interest from other retailers, while European retailers are looking to switch back to green from black.

It may be too early to decide whether this will support an acceleration in RPC, of which IFCO could benefit. The opportunity is there as the market share for cardboard falls away.

Brambles is trading at a material premium to the All Industrials, ex banks and resources. Citi believes this is fair, given the market position that CHEP occupies as well as the high levels of return on capital that the business delivers. The broker is cautious about the ability to deliver the stated returns from the additional growth capex, but recognises the quality of the business nonetheless.

Consequently, management is expected to deploy growth capex only when it makes sense for the long-term benefit of shareholders and Citi's Neutral rating is retained. On the other hand, Deutsche Bank believes the market is too sceptical in pricing in the potential in the stock. The broker is attracted to the long-term business model, despite the risks of not meeting targets, and sticks with a Buy recommendation.

Pallets in the Americas were a drag over recent years, and improving the return to 25% from the current 18% is the chief enabler of a better performance, UBS contends. The broker considers the business a solid and defensive growth story, which should deliver 6-9.0% per annum earnings growth in the medium term. However, expectations for double digit growth could somewhat ambitious.

FNArena's database contains three Buy ratings and four Hold. The consensus target is $10.71, suggesting 9.9% upside to the last share price. Targets range from $10.29 to $11.11.
 

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