We recently researched Brambles (ASX:BXB) in The Dynamic Investor, after the Company issued an update for the three months to 30 September 2023 (1Q24). Group revenue growth for 1Q24 was stronger than expected and above the FY24 guidance range of +6-8%. This likely appears conservative, with BXB erring on the side of caution in light of uncertainty around several factors. These include customer volumes, success with CHEP winning new business and pricing.
While the share price has recovered since our report, it remains below recent highs. At current levels, is there still reason to be cautious, or do the shares still present value?
Brambles is the largest provider of pallet services. The Company’s main operations comprise the CHEP (pallets) division, which has operations in Americas, Europe, Middle East & Africa (EMEA) and Asia. In the US, Europe and Australia, CHEP’s market share is estimated to be 55%, 25% and 70%, respectively.
Key Fundamental Drivers
Pricing Power Remains
Following a strong period of negotiated contract repricing over FY22-23, pricing momentum has now slowed. Company commentary regarding increased competitor activity suggests that the tailwinds from recent years are coming to an end.
At the recent trading update, the Company commented that pricing on current-year contractual renewals continued to increase. However, the Company also said they expect current-year price realisation to align with a lower cost-to-serve environment.
BXB is aiming to hold on to its pricing increases, particularly those reflecting the higher cost-to-serve, even as surcharge-related pricing declines through FY24. There is also evidence that industry pricing is declining and competitor behaviour remains rational. However, there is a risk that key pooling and white/recycled pallet competitors may increasingly use pricing as a strategy to win/maintain share.
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Prospects for Recovery in Volumes
Volumes with existing customers in the US and European pallet businesses continued to decline in 1Q24. However, the rate of this decline moderated compared to the prior quarter. This reflected broader consumption activity and improved pallet availability across the Company’s US and European network.
There are several factors underpinning expectations for improved volumes in 2H24/FY25. Notably,
i. Gradual destocking from manufacturers and retailers is expected to continue as a slight volume headwind through FY24. Having said that, most retailer destocking now appears to have happened.
ii. The benefit from higher pricing (i.e. through pass-through inflation and re-pricing of contracts) is reducing. Despite this, increasing pallet availability should see a return to volume growth. Pallet return rates continued to improve in 1Q24, reflecting BXB’s asset efficiency program through progressive inventory optimisation at retailers and manufacturers. Accordingly, this has led to improved pallet availability and increased plant stock levels in all markets.
New Customer Wins to Support Revenue Growth
New business wins in 1Q24 were modest. This was due to the CHEP US and Europe teams being actively engaged with the new business pipeline to convert customers from single use alternatives. BXB have seen an increase in new customer contract wins and expect new customer contract wins to continue increasing in 2Q24.
Net new business wins in the US were broadly flat over 1Q23. This is an encouraging signal that the Company has been able to offset the impact of customers switching to cheaper whitewood pallets so far through new contracts.
Margin Expected to Remain Resilient
Despite the expectation of declining revenue in FY24, group EBITDA margin is still expected to remain resilient. Notably, margin expansion is still expected for the CHEP Americas segment. Firstly, the spread between US wooden pallet prices and their lumber cost inputs remains positive. The latter is due to customer destocking and increased lumber availability.
Secondly, the impact from Irrecoverable Pooling Equipment Provision (IPEP) charges is approaching its peak. This is likely to be supportive for underlying EBIT margins through FY24, as trends stabilise and asset cycle times return closer to the pre-COVID peak.
Further Reduction in Gearing Expected
The 1Q24 trading update did not contain commentary on gearing levels. Importantly, gearing remains well below management’s target of <2.0x. There is also significant financial flexibility with over US$1b of undrawn committed facilities and US$0.2b of cash balances.
As a result of improving free cashflow, gearing is expected to fall further in FY24. There is increased balance sheet optionality from a reduced gearing position. As such, this provides increased scope for further capital management initiatives (i.e. share buybacks).
The shares are currently trading on a 1-year forward P/E multiple of ~17x. While increasing since our recent report, this remains at a ~20% discount to the average multiple over the last three years. Further, the current multiple is attractive when compared to the EPS growth profile (in US$ terms) of +11% over FY23-26 on a CAGR basis.
Brambles is still trending lower after peaking in September. It has recovered over the past few weeks but it is now retesting the underneath of this downtrend line. This means that the next few days are “make or break” for BXB. A push above the blue line would be a positive, otherwise a failure to kick on here could see it drift to lower levels again.
Michael Gable is managing director of Fairmont Equities.
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