Brambles’ Divisive March Quarter

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A negative reaction to Brambles’ March quarter update suggests more was expected, but brokers, while split, are largely positive.

-Brambles sees slowing sales growth
-Destocking both a drag and a benefit
-Free cash flow improvement expected
-Diverse views among brokers

By Greg Peel

Brambles’ ((BXB)) March quarter group sales grew by 2% in constant-currency terms on slowing-but-positive price growth of 3% and continued negative volumes, down -1%.

Management reiterated guidance for FY24 sales growth of 6-8% in constant currency, and 13-15% of earnings growth, but Macquarie’s expectation is that FY24 will be towards the bottom half of guidance. Price was a major driver in first half, and this has virtually disappeared in the US, up only 1% and down to 4% in Europe, Middle East & Africa (EMEA).

In the first half, price increases offset the impact of the destocking and the effect of contract loss, Macquarie notes. March quarter revenue in America was down -1%, EMEA up 2%, with only Australia improving materially, up 6%.

The destocking cycle, which was well flagged to investors, released around three million pallets. This is dampening growth, the broker suggests, not just with existing customers, but is also slowing conversions to CHEP, as the white wood secondary market is also over-supplied (with lower pricing).

For CHEP this destocking cycle should run its course in FY24, albeit it is hard to see the signs of growth rebounding, Macquarie warns.

All in the Price

Brambles has continued to navigate a challenging operating environment well, Morgan Stanley suggests, with price realisation the key driver of revenue growth. This broker notes, however, slowing price momentum from 11% growth in the first half to 8% in the March quarter.

As was the case in the first half, new price initiatives contributed 3%. Morgan Stanley is also seeing a slowdown in the trajectory of sales growth within group revenue. September quarter sales growth was 22% year on year, the December quarter saw 4% and the March quarter faded to 3%.

Net new business growth has still not accelerated. Brambles thinks this is a reflection of a "slower than expected ramp up" in new customer volumes but also a result of some volume loss due to a shift to dual sourcing (customers using two pallet suppliers instead of just the one). Morgan Stanley thinks the lower net new wins demonstrates that competitive activity remains.

However, it is encouraging that at this stage, price discounting is not evident. The broker continues to view this as the biggest risk.

UBS notes sales guidance now requires 3-11% growth in the June quarter, implying an improvement from the March growth rate. This broker believes it's reasonable for June growth to step up from March based on the easier comparable period a year ago, particularly due to volumes. June quarter FY23 volume was unusually weak (-7%), likely due to destocking at the time.

Brambles expects FY24 overall volumes to be flat year on year, implying to UBS roughly 3% growth in the June quarter.

Benefits of Destocking

While customer destocking of pallets has been a drag, there is a benefit.

The positive of the destocking cycle, notes Macquarie, is that the release of pallets saves on capex demands, improving cycle times and improving loss ratios. Hence, Brambles’ reiteration of 8-10 basis points improvement in capex-to-sales, and strength in margins.

The latter is moderated by higher operating costs (inflation) and transport costs in Europe. Cash flow however benefits, with guidance reiterated, and combined with low leverage as it is a matter of when capital management will be adopted -Macquarie suggests– maybe with the full-year result.

Jarden suggests focusing on monthly revenue run-rates is far too narrow and is missing the slowdown in the rate of returning pallets, which should see “inventory optimisation” moderate as a revenue/volume headwind into the June quarter and FY25.

In this broker’s view, the market is looking for the causes of deleverage/lower margin growth into FY25 but it is missing the opportunity from "cycle time decreases in all regions", which not only help free cash flow, but should also provide support for declining Irrecoverable Pooling Equipment Provision charges into the second half.

Jarden estimates a “normalisation” in IPEP costs could contribute 139 basis points of underlying earnings margin to CHEP Americas and 31bps to CHEP EMEA into the future.

Valuation

Brambles’ March quarter result lacks the green shoots of volume growth, Macquarie laments, but increased efficiency and improved cash generation creates value, hence capital management is likely by end of year. Evidence of volume growth will ignite further upgrades.

At 16.6x forecast FY25 PE, versus a long-run 19x, the stock looks attractive in Macquarie’s view, hence the broker retains Outperform.

The result modestly lowered UBS’ constant-currency earnings forecasts, but it hasn't changed the investment view. This broker expects growing confidence in Brambles' free cash flow recovery will drive re-rating of the PE multiple.

Brambles is trading on a multiple -24% below the average of ASX industrials, which UBS thinks is too low and suggests disbelief in the sustainability of earnings and free cash flow. The broker thinks the market is currently too focused on top line/cyclical momentum when more attention should be placed on margin stability and free cash flow improvement.

UBS retains Buy.

With like-for-like volume trends set to improve as destocking headwinds abate, Jarden sees consensus revenue growth of 4% as achievable into FY25, all else remaining equal. This broker’s review of consensus CHEP Americas’ underlying earnings margin shows only 35bps growth of margin expectation in forecasts, which could be underpinned entirely by an ability to unwind half of the IPEP margin headwind relative to history.

Jarden maintains Overweight.

Brambles noted three million pallet returns from destocking which has halved relative to the first half, Barrenjoey notes. The company highlighted it is now cycling destocking in the second half with the flow-on effects to operating costs and pooling capex also moderating.

In addition, the impact of dual sourcing is also moderating. Lastly, the company highlighted it is seeing cycle times decrease in all regions and lower loss rates.

Barrenjoey retains Overweight.

The March quarter update points to a continuation of trends flagged in the first half and all guidance items were maintained. That said, Morgan Stanley feels the market was looking for upside. Net new contract wins remain elusive pointing to competition, the broker suggests, whether via dual sourcing or other means. This remains a key risk to Morgan Stanley’s view, hence an Equal-weight rating.

Brambles is a global, defensive business with strong market positions which continues to demonstrate an ability to pass higher costs onto customers through increased pricing, notes Morgans. However, price rises are moderating and while the company continues to extract operating efficiencies, the underlying consumer demand environment in the US and Europe remains soft.

Given the uncertain global macroeconomic outlook, this broker believes the stock is trading near fair value and maintains a Hold rating.

Yesterday's market update was in line with Ord Minnett’s expectations, and this broker has maintained forecasts. An FY24 revenue growth forecast of 8% year on year is at the top end of company guidance. With Brambles trading at only a modest premium to Ord Minnett’s fair value estimate, the broker upgrades to Hold from Lighten.

Not everyone is of a similar view nonetheless.

Overall, Citi expects investors were largely looking for an upgrade, driven by bottom-up initiatives to offset rapidly falling sales growth. While guidance was maintained, Citi's view is the lack of upgrade implies profit growth is slowing, and with FY25-26 cycling tough pricing comparables, growth could become tougher.

Ultimately, Citi believes Brambles, while structurally a better business now, was still a cyclical beneficiary of the pandemic, and after years of outsized returns is likely due for a period of consolidation. Hence, a Sell rating.

Goldman Sachs also retains Sell.

Among the six brokers covering Brambles monitored daily by FNArena, there are two Buy or equivalent ratings, three Hold and one Sell. The consensus target is unchanged at $15.44, but ranges from $14.00 (Ord Minnett) to $17.30 (UBS).

Barrenjoey (Buy) has a target of $17.90, Jarden (Buy) $15.70 and Goldman Sachs (Sell) $14.45.

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