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Brambles (OTCPK:BMBLF) is a defensive business that continues to grow amidst COVID-19 pandemic and yet trades at a discount to its long-term average multiple. The company’s publicly announced share buyback and dividend (2.5%) will provide additional returns for investors beside expected share price appreciation on the back of improving fundamentals of the business.
Brambles is a global supply chain logistics company that specialises in the management of the world’s largest pool of reusable pallets, crates, and containers. The company’s main operations involve the outsourced management of returnable pallets under the CHEP brand. Manufacturers, producers, distributors and retailers use pallets to transport their products safely and efficiently across their respective supply chains. Brambles provides extensive network to support global supply chains managing the issue, collection, repair and reissue of pallets around the world.
Resilient business model against COVID-19 with over 80% of its revenues generated from food & beverages and FMCG customers
I would expect Brambles’ earnings to be resilient, given the essential nature of its services with 80% of end market exposure to food, beverages, and FMCG customers. Brambles facilitates the transfer of goods, even more so in the current COVID‑19 environment with increased levels of demand for consumer staples and lower turnaround times to re-stock products. This was evidenced by its 3QFY19 trading update on 17th of April where it reported 6% of revenue growth despite volatile conditions amidst COVID-19 environment and re-affirmed its full-year guidance for FY20 in an environment where most companies are withdrawing earnings guidance.
Rock solid balance sheet and share buyback
Brambles has a rock solid balance sheet with its cash on hand of A$ 1.1 billion and U$1.3 billion of committed undrawn facility. Its leverage ratio (Net Debt/EBITDA) was 0.9x, and it maintains investment grade credit rating from S&P and Moody’s. The next debt maturity is in June 2021 for U$200m. Brambles sold one of its less attractive parts of business – IFCO – in 2019 for an enterprise value of US$2.51bn (EV/standalone EBITDA of around 10x). The sale allowed Brambles to reduce gearing to conservative levels and return US$1.95bn to shareholders via a pro-rata cash return of US$300m, along with an on‑market share buyback of up to US$1.65bn. The execution of the share buyback would result in the re‑purchase of up to around 15% of Brambles’ issued capital and support strong EPS growth over the next few years. Brambles has completed ~36% of the buyback to date, with expected completion of the remainder by the end of FY21.
Upside potential through margin expansion
Brambles has faced increasing cost pressure in the United States as labour, freight, lumber and property rental prices have increased over the last few years. The US business comprises ~70% of the CHEP Americas segment and ~35% of Group Revenue. EBIT margins for CHEP Americas have declined from over 20% in 2016 to 13% in FY19 largely due to the cost pressures mentioned above. The company has put in place a number of mitigating actions, including pricing surcharges to pass on cost increases, automation to reduce capex/repair costs and procurement initiatives to reduce lumber costs. These initiatives are expected to deliver a cumulative 2‑3% improvement in US margins for the next 3 years, with the 1H20 results delivering on this target improvement. I believe that 2019 was the low point for Brambles’ US margins with the potential for double‑digit EBIT growth from CHEP Americas as these mitigating actions are executed.
Improving FCF generation
Brambles’ FCF conversion has been volatile over the past few years largely due to an increase in growth capex in order to expand the pooling network, greater asset inefficiency from longer cycle times, increased repair costs, and lost pallets as well as a decline in US margins. Pooling capital expenditure as a percentage of sales increased from ~17% in FY14 to around 20% in FY19. The company’s medium-term target is to reduce this percentage back to ~17% which would deliver an additional US$100m p.a. or a ~40% increase to FY19 free cash flow. 1H20 results demonstrated a 180bps reduction in pooling capex/sales indicating the company is making strong progress towards its medium term target.
Brambles’ pooling network and infrastructure have been developed over a very long period of time with no comparable peers at close to a similar scale. Brambles has five times more pallets in circulation than its nearest competitors in Europe and the US and a considerably larger service centre network. I believe the strategic importance of the Brambles network and its high barriers to entry would be highly attractive for a financial sponsor buyer and increases the likelihood of a potential takeover. Private equity firms have shown strong interest in owning pooling assets and comprised the large majority of the buyer universe when Brambles sold IFCO in 2019.
Brambles currently trades on only 7.9x FY21 EV/EBITDA based on consensus estimates against its long-term average of 9.3x – 30% upside potential if the company’s valuation multiple could be re-rated based on its strong performance and its S/O reduces by just 10%. In addition, the company sold IFCO for around 10x EV/EBITDA. I believe current valuation of Brambles provides an attractive entry point for a company with high barriers to entry, resilient business model, and a number of clear positive catalysts to drive continued solid earnings growth going forward.
Source: Bloomberg; Author’s calculation
Changes in economic activity that influence demand for FMCG;
Changes in inventory management by key customers and distributors;
Changes in competitive behavior by competitors;
Changes in pallet loss and damage rates; and
Changes in Brambles dividend payout ratio (45%-60%).
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.