28 May 2019
Reach Markets publish the notes from our analyst meetings with company management. They should be read in conjunction with the research we’ve completed. Reach Markets endeavour to provide self-directed investors a seat at our investment meetings. We publish these notes in a conversational format to get these out as quickly as possible for your consumption.
We recently had a one-on-one meeting with Sean O’Sullivan from Brambles Ltd (BXB). The meeting was used as a refresher on the BXB story as well as to reassess our investment thoughts on the Company. Below are the key points from our discussion.
Remuneration structure adjusted for asset efficiencies
Management team now has asset efficiency KPIs as part of their rem structure, with 20% of the short-term incentives could be lost if asset efficiency targets are not met. Given’s BXB’s heavily reliance on asset efficiencies, Mr. Sullivan noted “what we want to show the market is that our business is very disciplined and its driving a better cash outcome and all that comes from asset efficiency.”
IFCO sale – demerger or trade sale?
The company is more interested to go down the path of a demerger, but they haven’t ruled out the possibility of a trade sale. The preference for a demerger also stems from the fact that the board believes a trade sale to Private Equity could likely result in the assets reappearing on the market in 5 years’ time. However, in our view, if BXB is offered more than $2.5bn for IFCO, the sale would proceed. Further, given the growth opportunities available in the business, management believes the shareholders should be given the opportunity to share in this upside. The Company expects the assets to achieve EV/EBITDA of 8-10x, which is largely in line with our expectations (as noted in our 27 Aug-18 report).
Mr. Sullivan noted that if the company decides to do a trade sale most of the money would go to a buyback. Mr. Sullivan provided the following reasons for BXB wanting to exit the business (in words to the effect of) – “It’s not absolutely crucial (to sell IFCO) as we think it’s not a bad business, but rather our review just simply found that we probably weren’t the right owners…it really came down to capital allocation, whenever we had the opportunity to allocate capital between two opportunities we had the choice of allocating money to CHEP, which is much higher returning or allocate capital to IFCO, where most of the allocation was in North America where returns are low…so even though I think IFCO has very good prospects if you are looking long term, it was likely blocking our capital…so separately it will be able to pursue its own opportunities and that will also help us increase our focus on our core business.”
Continuing operations – inflationary cost pressures and pressures faced by clients
BXB has been experiencing cost pressures, not only because of inflationary pressures but also because retailers have seen increased competitive pressure (i.e. discounts) who have in turn put pressure on manufacturers (core customers of BXB). In such an environment, BXB clearly was operating in an environment where pushing price increases to its customers (manufacturers) wasn’t realistic given manufacturers were under pressure from their respective customers. However, Mr. Sullivan noted (in the words to the effect of), “…what’s changed quite dramatically though in the last 6 months is behaviour of our competitors (become rational) so we are forced to take price irrespective of the inflationary pressures…” This indicates that despite increasing prices, the lack of cheaper alternative options, BXB is retaining business (and in fact winning new customers in SME space) whereas before, there was the risk of losing customers. Last year, BXB achieved underlying growth of 3% in APAC (with flat margins) and 8% in Europe (flat margins) and management expects it to be same for FY19.
Revenue model (refresher)
BXB’s revenue model has a relatively attractive payback period, where pallets go from BXB’s service centre to the manufacturer (core customer), who pay an issue price to BXB upfront depending on the number of pallets they have ordered. BXB collects the pallets from the manufacturer’s different sites and repairs them for re-use (cost of collection and repair is borne by BXB). Each pallet does around 3 to 3.5 such cycles a year. A pallet costs BXB $20 and it earns $5 each cycle. BXB is in the process of digitalising the process to keep track of the pallets in areas of high loss rate, which should lower capex and opex.
Automation represents upside
Sullivan noted in the words to the effect of, “currently 80% of our European service centres are 70% automated and 25% of the U.S. ones are at that level of automation; the program will increase the 25% in the U.S. to 85%…the game changer here is AI and machine learning because automation in the old concept doesn’t help us because automation in normal factories is based on everything being standardised and the problem for us is everything that comes in [speaking of pallets] is damaged differently, so the machines have to be able to learn to identify the different damages and repair them…in 5 years you might see us having fully automated factories, with just a computer guy controlling everything.”
Is China and India an opportunity for future growth?
Sullivan noted that whilst China is on a trend to resolving logistics issues, there was still some way to go. He mentioned that trucks in developed nations are standardised/optimised and in the right design for moving goods around, whereas in China, the trucks are of different shapes and sizes and as such, a manufacturer would have a forklift driver move a pallet close to a truck, then ~20 employees to load the goods manually (by hand). By contrast, in the developed world, the forklift driver would load the pallet of goods onto the truck (which is designed to accommodate) straight away and the goods are delivered. Separately, on India, the infrastructure as well as the design of the trucks are not accommodative of moving goods.
From our discussion with Mr. Sullivan, we think it does not really matter what new trends are in supply chain or logistics, given the basis of moving products is still on pallets and e-commerce is not going to have an adverse impact on BXB’s revenue model, rather BXB is a beneficiary to e-commerce players as they help to move the products quicker.