Brambles’ Cost Recovery Challenge

Australia | 11:38 AM

While Brambles faces network disruption and repair constraints delaying margin recovery, some analysts believe these issues will prove temporary.

• Subcontractor exits trigger network disruption for Brambles
• Repair constraints may delay a potential margin recovery
• Measures to improve service levels and pallet availability
• As forecasts and target prices fall, two brokers downgrade their rating

By Mark Woodruff

Brambles ((BXB)), the world’s largest pallet pooling operator, has historically demonstrated a strong ability to recover higher operating costs through pricing, even during weaker macroeconomic conditions.

Against this backdrop, management has been increasingly highlighting the need to improve pallet quality. Now this challenge has been exacerbated by network disruption tied to subcontractor capacity constraints in pallet repair operations.

This week's trading update update by management revealed two service centre subcontractors representing around 10% of volumes have decided to exit the network.

Central and Northeast markets in the US have been impacted, limiting CHEP’s ability to utilise the circa 4m pallets currently sitting unrepaired in storage.

In addition, ongoing cost-of-living pressures and broader economic weakness continue to weigh on demand conditions across Europe, Morgans observes.

Left with no other choice, management downgraded FY26 earnings (EBIT) growth expectations to 3%-5% from 8%-11%.

The share price cratered by around -20% on the day.

RBC Capital explains Brambles was a relatively crowded trade prior to the update and the market is now expected to adopt a more conservative stance on FY27 until management can demonstrate the cost headwinds have been resolved and outline a clear recovery pathway. 

This time around, Macquarie believes Brambles will be unable to recover the additional contractor-related costs through pricing in the near term.

The Brambles business

Brambles operates a network of reusable pallets, crates and containers across more than 60 countries, primarily under the CHEP brand.

Macquarie highlights Brambles plays a critical role in global supply chains, working closely with manufacturers, producers, growers and retailers.

The company’s largest end markets are fast-moving consumer goods (FMCG), beverages and fresh produce, which collectively contribute more than 75% of group revenue.

Geographically, Brambles has its greatest exposure to North America and Western Europe, which together account for more than 90% of revenue.

Current contractor issues are expected to cost around -US$60m in FY26, including approximately -US$40m in additional supply chain expenses, with the balance reflecting customer mix and volume impacts.

Management aims to spend a further -US$60m to purchase around 2m new pallets in the June quarter “to support customer service continuity” and expects “further purchases in the first half of FY27, subject to demand”.

More takeaways from the trading update

Morgan Stanley views improving demand conditions in the second half of FY26 as encouraging and continues to regard current operational pressures as cyclical, with pricing expected to ultimately offset margin compression over time.

RBC adds Brambles experienced “higher than anticipated customer demand” from April, with management noting on the analyst call that organic growth would have been positive year-on-year absent the Service Centre disruptions.

This broker also highlights net new business momentum is ongoing, with sales teams expanding into regions unaffected by the operational issues.

Prior to the trading update, RBC believes the market’s major concern focused on ongoing momentum for organic volume growth (which was confirmed) along with net new wins into the June quarter.

Management reaffirmed its FY28 margin expansion target of 300 basis points relative to FY24 and expects current fuel and transport inflation pressures to be progressively recovered through pricing over time.

Jarden remains more cautious than management given several unresolved risks.

These include limited visibility around the extent of cost carryover into FY27 and the potential for structurally lower margins in CHEP Americas as collection and repair functions are increasingly brought in-house.

Uncertainty around the group’s ability to recover higher servicing costs through pricing while maintaining industry pricing discipline is seen as yet another risk.

Subcontractor issues

Morgans explains issues are driven by high turnover at service centres, labour shortages and elevated supply chain costs, including higher repair, handling, transport and storage expenses.

Higher pallet relocation and transport costs during a period of elevated fuel prices are being compounded by rising labour expenses as Brambles adds shifts and increases wage rates to expand repair capacity across the network

Management expects US pallet repair capacity constraints will prove temporary, targeting resolution by the end of December 2027, with improvement initiatives already underway.

While the company expects costs to be recoverable over time through contractual mechanisms, the issues appear material to Macquarie and unlikely to be resolved quickly.

Mitigating measures

To improve service levels and pallet availability, Brambles has increased pallet relocations, expanded repair capacity and purchased the above-mentioned 2m pallets in a supply-constrained market.

Macquarie expects network normalisation will extend to FY28, delaying the anticipated margin expansion trajectory.

While FY26 constant-currency revenue growth guidance has been reduced to 2%-3% from 3%-4%, it’s noted ongoing new business wins in the US and Europe continue to provide support.

Capital Management

The company also announced a new US$400m share buyback alongside narrowed FY26 free cash flow (FCF) guidance of US$1.0bn-US$1.1bn, from a prior range of US$950m-US$1.1bn.

While the additional buyback is positive, RBC explains it largely brings forward capital management the market had expected alongside the FY26 result this coming August.

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