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Brambles: No Plastic, Fantastic

Australia | Jul 04 2022

Brokers generally approve of the decision by Brambles not to proceed with plastic pallets for Costco.

-Brambles decides not to proceed with plastic pallet trials
-Credit Suisse believes shares may now reverse an ‘investment discount'
-Has an advantage been handed to US competitors?
-Defensive revenues provide some protection against a US recession

By Mark Woodruff

Brokers generally approve of the decision by pooling solutions company Brambles ((BXB) not to proceed with plastic pallets supply for Costco’s US supply chain, after a couple of years of trials.

Management indicated the higher cost of plastic pallets relative to wood made any transition prohibitive.

Costco’s transition to another plastic pallet provider over time remains a risk, which Macquarie estimates would impact around 10% of Brambles’ volume. However, it’s thought the company could pick up new customers through a transition period, though potentially at lower returns relative to Costco.

Outperform-rated Credit Suisse agrees on the company’s ability to acquire new customers, and doubts if smaller competitors in the North American market could derive an attractive return, given the relative network scale advantages of Brambles.

Overall, Macquarie likes the company’s ability to deploy pricing and surcharge mechanisms that enable a pass-through of cost inflation. In addition, 80% of revenues derive from defensive industries, which is expected to provide protection should the US enter a recession.

The broker maintains its Neutral rating and reminds investors cash generation is challenged by the volatility of lumber pricing and ongoing investments directed towards digital and supply chain initiatives.

This cash generation would have been further disrupted had the company decided to invest around US$450-700m in plastic pallets in North America. Indeed, Credit Suisse now believes a significant discount in the company’s share price on investment concerns may now reverse.

Morgan Stanley is not so sure on this point, and feels the prospect of a reconsideration by management, should plastic prices decline, will continue to weigh for shareholders. This is because the cost of plastic pallets, which has increased by around 50% since September 2001, was a key factor in the decision not to proceed.

Has an advantage been handed to competitors?

The investment in plastic pallets did not meet Brambles’ 18% hurdle for return on invested capital (ROIC). The trials showed plastic economics are difficult, even at Costco’s scale and high turn rate.

Credit Suisse estimates the company would need 100% higher unit revenue for plastic pallets compared to wooden pallets to get a ROIC in the 17-18% range.

While a competitor may have a lower hurdle, UBS feels they would also have higher unit capital costs, transport costs and loss rates versus CHEP’s existing scale, network and digital investment. Also, given rising funding costs, it’s considered challenging for anyone to currently supply the required capital.

Citi agrees that an increased cost of capital is one factor that reduces the risk of providing a leg-up to a competitor. It’s estimated the cost of capital is double digits at least, given rising interest rates, expanding credit spreads, less liquidity in the system and volatile equity markets.


UBS remains Buy-rated on Brambles after the Costco announcement and still expects a substantial free cash flow recovery in FY23 and FY24, while Ord Minnett cites the recent moderation of lumber costs, a strong balance sheet and an undemanding valuation to justify its Buy rating.

Jarden, not one of the seven brokers updated daily in the FNArena database, believes investors should be attracted to the company’s defensive end-market exposure and ability to offset inflationary headwinds.

Based on the replacement value of the company’s global pallet pool and comparable M&A multiples, the analysts assess the current share price is materially undervalued. The broker’s Overweight rating and 12-month target price of $11.50 are maintained.

The FNArena database has seven brokers with four Buy (or equivalent) ratings, two Holds and one Sell with an average target price of $12.14, which suggests 8.4% upside to the latest share price.

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