Cost Pressures Easing For Brambles Over FY19

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This story features BRAMBLES LIMITED.
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Cost inflation has stymied growth in the first weeks of FY19 for Brambles but the company remains confident cost pressures will ease as the year progresses.

-Challenging operating environment over the short term
-Gradual improvement in margins expected
-De-merger of IFCO expected to provide balance sheet options
 

By Eva Brocklehurst

Brambles ((BXB)) has pointed to significant cost inflation in the September quarter, which explains why growth is likely to be a missing ingredient in the first half. Importantly, the pressures appear to be easing.

The company reported revenue growth of 6%, highlighting that price increases offset most of the high cost inflation experienced during the September quarter. UBS also points out that growth in Europe, Middle East and Africa (EMEA) for CHEP of 8% shows the benefit of index price rises offsetting cost inflation.

The broker believes the company's update regarding easing cost growth is reconciled with previous commentary regarding pricing initiatives that should recover all European and half of the US cost increases. Pricing conditions also look strong in the US for white wood and cost increases are being eased across transport and lumber.

After peaking in May, Morgan Stanley notes North American lumber prices declined rapidly and, while transport cost inflation remains elevated, there is a demand-driven easing of trucking market constraints.

Ord Minnett suggests earnings growth should improve as the impact of elevated costs fades during the year and operating leverage comes to the fore. The broker reiterates a Buy rating as Brambles is its top pick in the transport sector.

The improvement in underlying profit growth in the second half should be driven, in part, Ord Minnett expects, by a better performance in the US from CHEP as well as a moderation in lumber and transport costs.

Morgans believes Brambles has a strong business with dominant global positioning and high barriers to entry but in the short term it is challenged by the operating environment, particularly in the US, and earnings growth is likely to be limited.

Margins

The expected acceleration in growth during the second half is a signal to UBS that the first half is likely to be the cyclical low point for margins, which have fallen to around 17.0% in the first half from 20.1% in FY16. On the other hand, Morgans suspects that given the rate at which costs are increasing, the company's initiatives will not be enough to offset a decline in margins in the short term.

The broker forecasts an earnings (EBIT) margin of 17.3% in FY19 before increasing slightly in FY20 as cost efficiencies ensue. Credit Suisse forecasts sequential margin improvements for CHEP Americas, and upgrades its rating to Outperform from Neutral. Earnings in the second half are expected to improve and reflect increases in prices.

Macquarie also expects an improvement in underlying profit in the second half, which will support margin expansion beyond FY20. The broker expects a recovery in margins for CHEP Americas to 17.2% by FY21, but below management's guidance.

IFCO

From press reports, Credit Suisse observes significant private equity interest in the IFCO RPC business which Brambles is seeking to sell, or de-merge. The broker considers a sale is more likely and bids are expected by Christmas. A sale at around 10x operating earnings (EBITDA) should generate around $0.72 per share, the broker calculates. An announcement is expected by March 2019.

Morgan Stanley upgrades, to Equal-weight from Underweight, noting the company has outperformed the market by around 10% since before its results. This is likely to be reflecting the enthusiasm surrounding a decision to separate IFCO and the balance sheet options associated with the sale or de-merger.

FNArena's database shows three Buy ratings and five Hold. The consensus target is $11.02, signalling 2.6% upside to the last share price. Targets range from $10.00 (Deutsche Bank) to $12.55 (Ord Minnett).

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