Analyst Research
1 March 2020
Brambles (BXB) FY18 result represents a resilient performance in times of significant costs inflation.
COMPANY DATA
| Date of Report | ASX | Price | Price Target | Analyst Recommendation |
| 27/08/18 | BXB | A$10.60 | A$11.85 | BUY |
| BXB | |
| Price A$10.60 | Price Target A$11.85 |
| Analyst Recommendation BUY | |
| Sector : Industrials | 52-Week Range: A$8.58 – 10.86 |
| Industry: Commercial Services | Market Cap: A$16,874.4m |
Source: Bloomberg
INVESTMENT SUMMARY
We rate BXB as a Buy for the following reasons:
- High barriers to entry for the market, solidifies BXB’s market-leading position.
- Massive opportunity to convert white-wood users as well as the palletisation of emerging markets.
- IFCO sale/demerger could raise up to A$3.0bn, which can be used for capital management or investment into growth opportunities.
- Strong management team with proven ability to maintain cost margins amidst cost pressures through strategic business efficiencies.
- Volume growth in the US Pallet business remains strong and is still expected to grow.
- Appreciation of the US dollar would have a positive impact on BXB’s earnings as most of its earnings are in this currency.
- BXB’s scale, existing customer base and balance sheet will ensure it remains a market leader in the mid-to-long term.
We see the following key risks to our investment thesis:
- Competitive pressures and cost inflation leading to margin erosion, particularly in the North American market.
- Operations are very capital intensive.
- Any further loss of large contracts significantly reducing revenue and earnings.
- Weak economic conditions will lead to less consumption of FMCG, and hence less use of pallets.
- Volatile whitewood prices.
- Exposed to a wide range of currency and political risks.
Figure 1: Revenue by segment
Source: Company
ANALYST’S NOTE
Brambles (BXB) FY18 result represents a resilient performance in times of significant costs inflation.
In constant currency terms on prior year, group revenue was up +6% (in line with guidance of mid-single digit growth) with all business segments except CHEP Asia-Pacific reporting sales growth.
This did not drop to the bottom-line, where underlying profit remained flat due to significant input cost pressures (transport, labour, and lumber costs). However, over 2H18 management successfully implemented several pricing actions to recover a portion of costs inflation and this is expected to roll-over into FY19, particularly as more contracts come up for renewal (one-third of BXB’s contracts come up for renewal every year).
Maintain Buy – we note BXB’s dominant market position and significant upside once the inflation cycle has peaked and BXB’s cost out and efficiency programs contribute to the bottom line.
Further, we estimate the IFCO sale/demerger could raise up to A$3.0bn for BXB.
- Key FY18 headline numbers. 1. Group revenue of US$5,596.6m was up +6% in constant currency terms on prior year, driven by organic volume growth and strong net new business wins in Pallets combined with expansion in IFCO; 2. Underlying profit of US$996.7m was flat in constant currency terms, sales contributions were offset by profit headwinds, including developed markets inflationary pressures, CHEP Americas cost pressures driven by network capacity constraints and conversion costs, along with the previously announced loss of a large RPC contract in CHEP Australia; 3. ROCI remained high at 16.1%, but deteriorated -90bps from FY17 due to the aforementioned contract loss; 4. Strong FCF generation of $554.4m (up +$330.2m on pcp) through combination of EBITDA growth and working capital management fully funded the final dividend payment.
- Cost pressures continue to cycle through the peak. As always, input cost inflation in transport, lumber and labour costs, was a key focus through the presentation, with management noting that current levels of cost inflation are unprecedented. Market inflation for transport was +10% in the USA and +12% in Europe, while lumber costs increased +13% in the USA and +6% in Europe. However, BXB’s pricing and surcharge initiatives to recoup these costs have been relatively successful, especially considering the inherent time lag, with pricing actions recovering US$33m of the US$52m in cost inflation.
- IFCO separation plans. The key talking point from the presentation was management’s intention to separate IFCO from BXB prior to the end of CY19, with plans for a demerger, but a sale has not been ruled out. The rationale being the two businesses are operationally and commercially independent with no meaningful synergies, and through separation, the individual investment needs of each business can be better met.
- FY19 outlook. The CEO noted that input-cost inflation will trouble FY19 underlying profit, and to expect BXB’s strategic initiatives to “progressively deliver efficiencies and earnings benefits over the medium term.” Over the medium term, BXB expects “constant-currency sales revenue growth in the mid-single digits”, driven by expansion and further conversions to pooled solutions, and for underlying profit growth to exceed sales revenue through the cycle.
FY18 RESULTS SUMMARY
Key FY18 results compared to prior year are provided in the table below. Figure 2: Summary of Results (Actual Currency) 
Source: Company, BTIG
Figure 3: Group profit analysis (USD$m) 
Source: Company
CHEP Americas (~39% of Group revenue). CHEP Americas revenue was up +5% in constant currency, driven by double digit revenue growth in Latin America pallets and reflecting improved volume momentum and price realisation. However, underlying profit declined -12% to $350.6m due to a 3.3bps compression in margin, driven primarily by inflation in CHEP USA (2bps), however, 0.4bps was attributable to increased investment in US pallet pool quality. CHEP Canada accounted for 0.6bps of this decline due to higher costs from acceleration in customer conversions from stringer to block pallets. CHEP Latin America accounted for the remaining 0.3bps as pricing initiatives were unable to recoup inflationary pressures. Management spoke to their plan to deliver a 2-3% improvement in the US pallets business, noting their supply chain cost out, further pricing, surcharge and procurement initiatives, as well as the automation programme, where BXB plans to invest $160m over the next 3 years, which aims to deliver cost efficiencies in line with CHEP EMEA.
Figure 4: U.S. general freight (long-distance)
Source: Bureau of Labour Statistics U.S.
Figure 5: Lumber price 
Source: Bureau of Labour Statistics U.S.
CHEP EMEA (~33% of Group revenue). CHEP EMEA delivered revenue growth of +8%, and underlying profit growth of +9%, achieving margin expansion despite input cost inflations. Europe saw strong volume growth of +6%, but pricing remained flat as indexation benefits offset strategic pricing initiatives. On the other hand, AIME (Africa, India and Middle East) saw both volume growth and price/mix benefits. Speaking to FY19, management are optimistic on this segment, expecting volume momentum to continue, but inflationary pressures are also expected to remain. Capital expenditure for the automotive business will also increase to support the new contract wins. CHEP Asia-Pacific (~9% of Group revenue). Sales revenue in the Asia Pacific business declined -4% on a constant currency basis due to the loss of a large RPC contract and the wind down of the automotive industry (both of which were flagged back in CY16) in Australia. On an underlying basis, profit grew +3% on modest price increases and solid volume growth. Going forward, the RPC business is expected to return to growth. However, FY18 had the benefit of $13m in asset compensations and these are not expected to recur in FY19. IFCO (~20% of Group revenue). IFCO reported +8% growth in sales revenue in constant currency, reflecting volume growth with retailers in Europe, price/product mix benefits in North America and volume expansion in Asia and South America. Margins expanded marginally by 0.3bps as sales contribution and efficiency gains were offset by higher depreciation and transport costs. Underlying profit was up +10% on a constant currency basis. IFCO could be worth up to A$3.0bn on our estimates. The key talking point from the presentation was management’s intention to separate IFCO from BXB prior to the end of CY19, with plans for a demerger, but a sale has not been ruled out. The rationale being the two businesses are operationally and commercially independent with no meaningful synergies, and through separation, the individual investment needs of each business can be better met. We estimate the demerger or sale of IFCO could raise up to A$3.0bn and will improve BXB ex IFCO ROIC.
Figure 6: What could the demerger/sale of IFCO raise? 
Source: Company, BTIG estimates; AUD/USD 0.75 – BTIG long-term estimate
Capital expenditure. Total PP&E capex grew +13% or US$132m in FY18 comprising investments in BXB’s various businesses, increased unit pallet costs due to lumber and transport inflation, while being marginally offset by improved cycle times. For FY19, pooling capex/sales ratio is expected to decrease due to improvements in asset efficiency, being slightly offset by new investments and cost pressures. Balance sheet. BXB’s balance sheet remains strong, having lowered net debt (down $265m to $2.3bn) over FY18 and improved its debt profile. Net debt/EBITDA was 1.46x, well below target of <1.75x, and significantly below FY17 of 1.73x. The average term of committed facilities rose from 3.7 years to 4.5 years. In the conference call, management noted that they have no need to refinance any of their existing bonds, and that they aim to maintain a “conservative balance sheet and a conservative debt rating”.
Figure 7: BXB Financial Summary 
Source: BTIG, Company, Bloomberg
COMPANY DESCRIPTION
Brambles Limited (ASX: BXB) is a supply-chain logistics company operating in more than 60 countries, primarily through the CHEP and IFCO brands. Headquartered in Sydney, its largest operations are in North America and Western Europe. The company’s main segments are: pallets, reusable produce crate (RPCs) and containers. It services customers in the fast-moving consumer goods industries and also operates specialist container logistics businesses serving the automotive, aerospace, and oil and gas sectors. It employs more than 14,500 people and owns more than 550 million pallets, crates and containers through a network of more than 850 service centres.
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