Brambles (BXB) is a logistics company focussed on serving the Fast-Moving Consumer Goods (FMCG), Fresh Produce, Beverage, Retail and General Manufacturing industries through its fleet of ~360m reusable pallets, crates, and containers. It operates primarily through its CHEP brand in ~60 countries and has a network of 750+ service centres, utilising a powerful circular business model, network advantage and expertise to generate value for customers.
Competitive advantage. The significant scale of its distribution systems and service centre network allows it to deal with complexity and serve demand channels that its competitors cannot. Larger scale allows for better unit economics, where barriers to entry increase as smaller operators are unable to sustainably offer a superior value proposition whilst delivering acceptable returns on capital. Further, the main alternative is the ‘whitewood’ pallet, which often has poor load bearing capabilities and volatile pricing linked to lumber.
Investor value proposition. At its investor day in 2021, BXB unveiled that it expects long term sales growth in the mid single digits driven by volume and price growth, with underlying profit growth in the high single digits, driven by optimisation of its operations from FY23 onwards. A high single digit EPS growth and dividend yield of 2-3% paid from free cash flow generation, is expected to generate shareholder value of ~10%+ pa.
Cashflow considerations. Return on capital invested (ROCI) has historically been in the mid-teens (1H23 at 19.8%), however, this has not always converted to strong free cash flows given the high capital-intensive nature of pallets. The high inflationary period over the last 2 years, particularly in lumber prices, has resulted in much higher cost to produce pallets, which BXB has been only partially able to recover. The company expects that as customers begin to return more pallets to BXB as they destock inventory and as cost inflation subsides, that the cash flow conversion should improve.
Investment View
BXB demonstrates high ROCI and has market leading scale, improving with network effects. The key issue however is the continued necessity of pallet replacement, which given the lack of visibility on its fleet, becomes difficult to accurately forecast. This also has significant implications for free cash flow, which has been negative in recent periods and therefore reducing potential shareholder returns. BXB trades relatively in line with its historical PE levels, and with a lack of clear near-term catalysts, we initiate on BXB with a HOLD recommendation.
Business Overview
Brambles (BXB) was technically established in 1875 as a butchery business in Newcastle, before gradually expanding its transport and logistics operations. Post World War II, the Australian Government took ownership of a collection of pallets and other transportation assets left in Australia by the US Army, and in 1946 introduced the name Commonwealth Handling Equipment Pool (CHEP). Brambles purchased CHEP from the Government in 1958 and moved its headquarters to Sydney. It expanded operations into the UK and Europe in the 1970’s and has made several acquisitions and divestments along the way. It now focuses largely on its CHEP business across North America, Europe and ANZ, along with some emerging markets exposure. The key segments that BXB serves are FMCG, Beverages, Fresh Produce, Packaging and General Retail industries.
Figure 1: 1H23 revenue by geography
Figure 2: 1H23 revenue by customer sector
‘Share and Reuse’ Operating Model
BXB provides standardised pallets, crates and containers to customers as and when the customer requires them. Customers then use the equipment and support services to transport goods through their supply chains. Customers either arrange for the equipment’s return to BXB or transfer it to other participants for reuse. BXB retain the ownership of the pallets throughout the supply chain, inspecting, cleaning and repairing as needed in order to maintain appropriate quality levels at its service centres.
Figure 3: The share and reuse of equipment in action across the supply chain
Whilst customers make best effort to return the pallets in a reusable condition, this is not always the case. Often pallets can become damaged or even lost throughout the process. Given the cost for adding a GPS into each pallet would make the process uneconomic, BXB technically is not completely aware of where each of its pallets actually are at any given time. It relies on the goodwill of the customers to leave the pallets where they say they do, and for the recipient to confirm the amount and the condition they are received in. This is a potential problem for BXB and it attempts to capture these potential loss rates within its contracts, although is not always successful in doing so, especially given most contracts are negotiated for a 3 year period.
There are essentially three fundamental elements to the pallet pooling business model, being loss, velocity and damage.
Loss: The control of the assets (pallets) is critical. Even though individual pallets are relatively low cost to produce (~US$25-35 in normal economic circumstances), any high-volume loss significantly reduces profit through write-offs, and requires more pallets to be purchased, impacting returns on capital and cashflow. On average, BXB expects to replace ~10% of its entire pallet network each year.
Velocity: Revenue is generated when pallets are issued or transferred, and in certain regions also on a daily hire rate. Therefore, BXB aims to ensure that its pallets are moving as frequently as possible to generate more revenue per pallet in shorter time spans.
Damage: Pallets can occasionally be returned in a damaged form, where BXB need to repair and service them before being redeployed. This is a key efficiency point BXB are working on to help improve the amount of time that its assets are out in the field.
Investor Value Proposition
BXB outlined its intentions to deliver 10%pa from FY23 in shareholder value. This is driven by mid single digit revenue growth, comprised of net new wins, like for like growth and price/mix benefits. Earnings growth of high single digits benefits from efficiency gains and earnings leverage from network/asset productivity.
Figure 4: BXB’s expected 10% pa value creation cycle
Competitive advantages
Across BXB’s key markets, the main alternative is the ‘whitewood’ pallet, which is typically bought outright by companies, rather than the rented model through BXB. Whitewood pallets are typically made from a weaker wood with lower load bearing capabilities and are often inconsistent in size attributes. The pallets are strongly linked to lumber prices, which can vary substantially across different geographies, which is more difficult to forecast into supply chain analysis for companies.
Each of BXB’s key markets has at least one reasonably sized competitor (typically though less than 1/3rd the size) providing some competitive price pressures, although competitors have been largely rational and market shares have been stable.
Another key alternative is ‘plastic pallets’ which BXB has trialled with Costco previously. Plastic pallets are able to include GPS trackers allowing for higher recovery rates, however they are at least 4x as costly to produce. This makes the unit economics very slim, with supply chain users not willing to pay 4x for pallets which provide a very similar function. The fact that BXB, the largest player was unable to make plastic pallets economic for one of the largest users (Costco) means that it is unlikely plastic will be a competitive force moving forward unless the cost to produce can fall dramatically.
Growth opportunities
BXB's growth is primarily driven by two factors: 1) an increase in the total addressable market and a shift towards pallet pooling due to supply chain fragmentation, resulting in a superior value proposition for outsourcing compared to insourcing over time, and 2) improved pricing due to market conditions and BXB-specific factors like BXB Digital. Additionally, BXB plans to expand geographically in existing and frontier markets such as China and Eastern Europe.
Price growth has not traditionally been a major driver for Brambles, but it can become dominant in certain market conditions, as demonstrated in FY22. BXB's pricing power is expected to increase incrementally over time due to digital innovation, the ability to identify higher cost customers and channels, zero waste/ESG guarantees, and customer network optimization services. Brambles has also added indexation clauses to most contracts in key markets, allowing for partial recovery of inflationary cost pressures. Revenue growth is forecast to be between 5-7% driven by a combination of net new customer wins, like-for-like sales increases and a price/mix uplift.
Figure 5: Large addressable opportunity geographically
Figure 6: 5-7% Forecast revenue growth
Net zero ambition
BXB's pooling model is also environmentally sustainable, as it reduces the need for single-use packaging and promotes circular economy principles. The company has set ambitious sustainability targets, including becoming a zero-waste company by 2025 and achieving carbon neutrality by 2027. This a key competitive advantage, with customers preferring to use BXB knowing that all of the materials are sustainably sourced and net zero waste, which will in turn be useful to present to their own investors.
Key Considerations
Efficiency measures – pooling capex to sales ratios
A lower pooling/capex ratio indicates better operational efficiency and loss rates of pallets. With rising inflation, the overall capex cost has increased over the last year as pallets were more expensive to procure and repair. The building of new pallet costs should abate as lumber costs return to more normalised levels, which is already evident across North and Latin America, however is yet to show through in EMEA, and can be seen in the below charts. BXB expects FY23 capex to sales ratio to improve by 3-4pts largely from increased return rates by a combination of asset efficiency initiatives and destocking across supply chains in the 2H.
Figure 1: North America pooling capex to sales ratio
Figure 2: Latin America pooling capex to sales ratio
Figure 3: EMEA pooling capex to sales ratio
Does visibility improve?
A key focus for BXB is to better understand its pallet tracking, and therefore improve loss rates. Attaching GPS trackers to each pallet will likely be uneconomic for many years. Whilst technology and better customer management systems will help, as well as increasing potential penalties for damaged goods that can be traced back to particular customers or channels which are higher risk. We still believe this will be an ongoing key issue for BXB and may continue to impact its cashflow and replacement cycles.
High ROCI not converting into free cash flow
BXB has historically had solid Return On Capital Invested (ROCI) in the high teens, despite this, free cash flow has been lacklustre. This is largely due to the significant cash capex nature of the business. More recently, it has been impacted by historic high inflationary levels impacting the working capital cycle, purchasing pallets at far higher prices, with pallets having longer dated payback periods and cashflows. We expect the almost negative free cash flows to unwind as inflationary pressures ease, however if capex levels remain elevated, there will be impacts to cash flow based valuations.
Figure 10: Historical ROCI has been solid
Figure 11: Weaker free cash flow on higher capex
Cost inflation and cost recovery
Throughout the last 2 years, raw material inflation, particularly lumber, has risen significantly, impacting pallet prices, with the 1H23 weighted average pallet price up ~14% on 1H22. BXB have strategically chosen not to chase new business given the significant increases in costs needed to purchase new pallets, instead preferring to service existing customers, and only add additional capacity once costs normalise.
Customers are currently sitting on elevated levels of inventory, given the over purchases to have stock available from potential supply chain issues and falling consumer demand from higher interest rates. Many BXB pallets are therefore sitting in customer warehouses holding old stock, impacting potential revenues for BXB. There is a daily fee clawback for customers who are holdings pallets past their contract dates, although historically this has not been a major source of revenue for BXB.
Destocking is expected through 2H23, with ~5-6m pallets expected to be returned to the BXB pool. With pallet prices also beginning to return to normal, this should see an improved cash flow cycle into FY24 as the network restabilises and operational efficiencies are realised. With large cost increases of pallets, replacement capex has been steadily rising over time.
Figure 12: Capex steadily rising on higher replacements
Figure 13: Lumber price index returning to normal
Are Management capable?
The current CEO Graham Chipchase joined BXB in 2017 from Rexam PLC and has overseen a solid execution of growth strategy. Chipchase however has one of the highest fixed base salaries of publicly listed ASX companies of US$1.8m, (~A$2.7m), far above the average ASX top 25 CEO of ~A$1.6m, although benefitting from a weaker $A during 2022. High fixed base salaries largely often do not align with shareholder interests, as they are less incentivised to address any underperformance of the business. From Chipchase’s start date in January 2017 up until 20 March 2023, BXB and the ASX200 have both returned ~60%.
The CFO Nessa O’Sullivan joined in 2017 and has recently just announced her plans to retire in 1Q24. The search for a new CFO is on, presenting some potential short-term risk.
Competitors
BXB faces competition from several players across different geographies. Competition has been rational in the last few years and is expected to continue to be as pallet availability improves. Unfortunately, these are all owned by private equity, so access to financial information is limited, but we provide a brief description below.
PECO: PECO is a pallet pooling company that operates primarily in the United States and Canada. The company is a subsidiary of Irving Consumer Products, a Canadian paper products company, and manages over 50 million pallets.
Euro Pool System: Euro Pool System is a European pallet pooling company that specializes in the supply of reusable plastic containers (RPCs) for the fresh produce industry. The company manages over 1.5 billion RPCs and operates in over 30 countries.
iGPS: iGPS is a pallet pooling company that uses plastic pallets equipped with radio frequency identification (RFID) technology for tracking and monitoring. The company operates primarily in the United States and manages over 10 million pallets.
Loscam: Loscam is a pallet and container pooling company that operates primarily in the Asia-Pacific region. The company manages over 30 million pallets and containers and provides a range of logistics and supply chain solutions to customers across different industries.
Valuation
Trading in BXB has been relatively volatile over the last 10 years, driven largely by changes in the PER. For us to become more positive on the stock, we would want to purchase at a lower PER. BXB has had several large acquisitions and divestments throughout its history and is now a much simpler and focussed business. With earnings momentum, there is scope for a re-rate, however until the cash flow issues are resolved likely in FY24, BXB will struggle to rate higher. The balance sheet is in solid shape, with a Net Debt/EBITDA ratio of just ~1.5x (~60% fixed rate), well below the policy of <2.0x.
Figure 14: BXB trading slightly below 10-year PER history
ROE and EPS have largely tracked together historically. Since the pandemic, there have been significant positive revisions, with BXB being able to push through price increases, as well as undertake a buyback of shares. We would expect ROE to remain in the mid 20%s, and expect EPS to grow between 8-10%pa, depending on the execution of its strategy. Further, BXB expect margins to improve as it delivers on its efficiency metrics and with lumber prices reversing.
Figure 15: ROE and EPS improving post Covid
Figure 16: EBIT margins expected to recover
Investment Thesis
Owning the largest fleet of reusable pallets in the world has many distinct advantages, where operating scale, expertise and procurement initiatives can lead to better client outcomes and higher margins. This is demonstrated through a solid ROCI over its history, and a track record of customer growth and market share gains. The sheer scale of its network allows it to be competitive in many regions, and also provides the balance sheet firepower for further expansion.
Cashflow remains a key issue, and the consistent replacement of ~10% of pallets each year is a significant working capital drag. Further, the actual loss rates can be much higher in any given year, given the visibility on pallets is extremely limited. Free cash flow has been weak in the past few periods driven by higher inflation and replacement capex, although BXB expect this to partially unwind over FY24. BXB currently trades relatively in line with its historical PER levels, and with a lack of clear near-term catalysts, we initiate on BXB with a HOLD recommendation.
Risks to Investment View
