Brambles: Brokers In The Dark

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

Brokers can only speculate on the real issues facing Brambles, but believe they may not be structural, suggesting value following the share price tumble.

-US inventory reductions, delayed new business affecting sales, margins and profits
-Sell off now suggesting substantial upside in the stock from current levels
-Questions arise regarding the quality of recent growth in the Americas
 

By Eva Brocklehurst

As US retailers sharply reduced their inventories late in 2016, Brambles ((BXB)) needed to make a sizeable downward revision to its first half guidance. The lack of clarity on ramifications of the downgrade, in what the market considers is a very stable business, has irked brokers. Also, new customers have taken longer to come on board, while there has been pricing pressure in the recycled pallets business.

Expectations for sales and underlying profit in the first half have been cut and Brambles is now expecting constant currency revenue growth of 5% and operational earnings (EBIT) growth of 3%. As such, the company does not expect to reach prior full year guidance of 7-9% and 9-11% respectively.

The largest impact is in the Pallets Americas segment, where margins are likely to have been reduced. Pallet returns following unexpected de-stocking have meant higher up-front transport and plant costs, without an ability to recognise revenue on returned pallets.

Deutsche Bank downgrades its FY17 estimates for earnings per share by around 8.8%, in line with the trading update. The company's long-term target of reaching a 20% return on invested capital by 2019 requires a much stronger contribution in FY17 compared with what now looks like being achieved.

Management has indicated the issues with inventory de-stocking peaked in December but the broker is concerned the second half is likely to experience a continuation of the trends. Also the company is now indicating that new sales in North America, expected to drive stronger growth in the second half, have now been deferred from the original time frame.

Goldman Sachs points out the lack of detail regarding the revisions means the stock will be subdued until the results briefing and revises its North American growth and cost estimates, reducing its target to $12.41. Goldman, not one of the eight stockbrokers monitored daily on the FNArena database, retains a Buy rating, as the stock now offers around 20% upside from current levels.

The fall in the price suggests the market has taken a more risk averse approach to valuation but the broker believes the additional discounting has been overdone. Ultimately, the impact of the issues could be short lived and a rebound is likely in coming months, although a lack of clarity makes any conclusion difficult.

Downgraded Guidance At Odds With Data

Morgan Stanley finds the downgraded guidance at odds with the positive data on US retail sales. This suggests there are other less defined factors which contributed to the warning and, in turn, raises further valuation and earnings risks. Although the stock is at its lowest price/earnings ratio in the last seven years, the broker maintains an Equal-weight recommendation.

The update raises more questions than answers for the broker as, assuming other regions grew in line with their first quarter run rates, it implies the Americas revenue declined by up to 3% in the second quarter alone. This potentially represents the first negative growth in the broker's data set since 2011.

Management's commentary on subdued demand and inventory de-stocking is also inconsistent with the data, in Morgan Stanley's view, which shows a benign environment for both. The broker notes US retail sales remain above average and continue to trend positively, particularly in key product segments such as food, alcoholic beverages and health-care products.

The broker suspects other factors such as contract re-pricing and market share may have contributed to the weak revenue growth in the first half. Hence, it raises questions around the quality of growth in the Americas recently and the fact this has absorbed a significant portion of the company's growth capital expenditure.

Value Emerging?

Morgan Stanley envisages potential for further downside to the FY17 earnings outlook, maintenance capital expenditure and the FY19 returns target. Nevertheless, and despite the near-term risks, the broker believes value is emerging, particularly if the downgrade is from explainable factors. Until the first half result the broker expects little visibility around new business, pricing and recycling conditions.

Of importance, Macquarie notes that Brambles believes the drop in business wins is not a reflection of failed tenders but rather delayed agreements because of extended decision-making processes.

The broker also believes the impact of de-stocking is short term in nature, particularly in the light of the supportive macro indicators and expectations for a boost in consumer confidence post the US election. Macquarie believes the share price reaction was excessive, given the strength of the company's growth outlook and the stock is a good buying opportunity.

The issue bugging UBS is how long the impact of de-stocking continues, noting the company is waiting to see January numbers before assessing the full year impact. In the meantime, UBS takes the view that it is a one-off step change lower in earnings and extrapolates the impact into the second half ,such that estimates for operating earnings growth are around 2% for the full year, compared with a previous forecast of 8%.

Despite the lingering uncertainty, the broker considers the business model intact, with its high barriers to entry still deserving a premium to the market. UBS upgrades its rating to Buy from Neutral. The broker considers this industrial growth stock has lower than average risk and its reliance on consumer staples and developed markets – with 45% from North America – provides a stable source of growth.

Potential For Further Negative News

Citi, too, is concerned about the lack of clarity, particular when there is another 28 days before there is more detail emanating from the first half results and the indications for the second half are outlined. Nevertheless, the broker does not envisage the issues as being structural and they should correct. As a result, Citi expects the share price reaction will prove to be an over-reaction.

CLSA is less sure and suspects something has gone wrong in the US business quite quickly. The broker acknowledges it was already sceptical regarding management's ability to achieve prior earnings guidance, but believes the increasing deviation between earnings and cash flow over the last two years is something a new CEO/CFO team needs to address after the February results.

The broker, not one of the eight monitored daily on the database, upgrades to Underperform from Sell. Investors are advised to take a medium-term view and be comfortable with the risk for further negative news.

FNArena's database has a consensus target of $12.05, suggesting 14.8% upside to the last share price. This compares with a target of $12.94 ahead of the update. There are four Buy and three Hold ratings.
 

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