The market’s unforgiving mood is creating opportunities for value investors and corporate predators. Investors are slaughtering companies that disappoint in this interim profit season, such is the pressure to justify valuations.
Brambles Industries is an example. Its board indicated last August that it was confident Brambles’ 2019 projections would be achieved. That followed the retirement of CEO Tom Gorman and appointment of new CEO Graham Chipchase, effective this month.
Brambles’ FY16 result was in line with its upgraded guidance – a good effort in a volatile global economy. The company expected underlying FY17 profit growth of 9-11% and reaffirmed its FY19 target of a 20% return on capital (ROIC) invested.
The well-regarded Gorman, CEO since 2009, was leaving Brambles in good shape. Its stock rallied from $6.40 at the start of 2012 to $13.64 in July 2016, just before the CEO succession announcement and FY17 interim result. Brambles was flying.
Then the momentum turned. Brambles last month downgraded its revenue and profit growth forecasts. It expected sales growth of 5% (earlier guidance was for 7-9%) and underlying profit of 3% (from 9-11%) – a terrible look in this market.
Brambles’ stock shed about 17% on the weak trading update. The selling momentum increased this week as the company released an interim profit in line with its lowered forward guidance.
Increased competition, cost pressures and customers’ pallet destocking weighed on the result. Brambles’ downgraded FY17 guidance for flat underlying profit growth disappointed. Also, the company said it would no longer provide medium-term performance targets.
Chart 1: Brambles
Source: Yahoo Finance
A key issue is whether weakness in Brambles’ Pallets North America division, the main contributor to its weak FY17 interim result, is temporary. Brambles said a large customer contributed to pallet de-stocking; more of an aberration than a trend. But rising pallet competition and network costs are also driving the division’s margin contraction.
Other Brambles divisions are performing in line with expectations. I suspect the company has provided an overly cautious view on the United States de-stocking trend – it would not be the first to lower market expectations just before the incoming CEO officially starts.
More will be known on pallet destocking trends as US fast-moving consumer goods retailers report fourth-quarter results and Christmas sales figures. The performance of Wal-Mart, a key pallet channel for Brambles, is especially important.
The odds favour slightly better fourth-quarter US retail conditions and volume growth, which flows through to pallet demand. Donald Trump’s election win in November boosted US consumer and small-business confidence to decade highs.
It is too soon to know how that has translated into retail inventories and pallet demand. But US conditions for Brambles should be slightly more favourable – enough at least to stem the trend of falling volumes and pricing growth in that division.
For all the short-term challenges, Brambles has attractive assets. The company is the largest provider of pallets and reusable plastic crates (RPC) pool services. The operations span 50 countries, mostly through the CHEP and IFCO brands.
Global scale provides competitive advantage, higher margins and an attractive return on capital invested for Brambles, in an essentially commoditised industry. Its relationship with many of the world’s largest retailers, consumer-goods companies and automotive manufacturers makes it harder for rivals to compete.
The company’s growth strategy is focused on expansion in emerging markets and conversion of white-wood pallet users in existing markets. Sustaining growth in the mature US and European markets is among Brambles’ biggest challenges.
Amid the current gloom, one can forget that Brambles has a sustainable competitive advantage, provided it can manage through the transition to online retailing, which affects pallet demand. The business is hard to replicate and strategically valuable.
Also, Brambles has superb leverage to an upturn in global economic growth, should it occur. This is an interesting time in the company’s next growth stage.
Is Brambles vulnerable to a takeover?
Labelling Brambles as a takeover target seems a stretch. A kneejerk reaction, perhaps, to short-term earnings weakness in a jittery market. Persistent takeover speculation swirled around Brambles about a decade ago (Toll Holdings was the mooted buyer) but nothing came of it. Takeover speculation might be off the mark again this time around.
But this column’s philosophy is to spot companies that are undervalued at the current price, and stack up with or without takeover. Corporate activity should be the icing, not the cake, for returns. Genuine takeover candidates are hard to spot, let alone get the timing right.
At $9.29, Brambles trades on a forward PE of 20.6 times FY18 earnings, consensus analyst estimates show. A median price target of $9.25, based on a consensus of 13 broking firms, suggests the company is fully valued at the current price.
Morningstar values Brambles at $11 a share and has an accumulate recommendation. Macquarie’s 12-month price target is $10.25. Share-valuation service Skaffold expects Brambles’ intrinsic value to rise from $9.19 in 2017 to $10.23 in 2018 and $11.72 in 2019.
Finding a catalyst to re-rate Brambles in the next months is hard. The third-quarter FY17 trading update in May 2017 will be closely watched, as will any signs of a pick-up in US retail sales growth, investors and thus pallet demand.
My sense is Brambles’ price downtrend will continue in the next few months, or consolidate in a sideways pattern, such was the magnitude of the market’s reaction to its earnings disappointment.
Some fund managers have publicly criticised the board’s handling of Brambles’ guidance downgrade and withdrawal from publishing medium-term targets. Several investment banks have reduced their Brambles valuation and recommendations. Clearly, the company has work ahead to restore market confidence and justify its valuation premium.
From a technical perspective, Brambles has broken price support around $10, a level it has tested and been supported at a couple of times since 2010. The next stop looks to be $9 on the chart.
Brambles will interest value investors – and perhaps corporate predators – if the price heads towards the next line of support around $8. It’s too strong a company to stay there for long.
Takeover portfolio update
The Switzer Super Report takeover portfolio had a mixed performance in January. iSelect and Challenger were standouts and some laggards in the portfolio narrowed their losses.
Brambles is added to the portfolio this week.
Source: Morningstar (one-year return), Standard and Poor’s (S&P/ASX 200 total return). * assumes dividend reinvestment. Prices at Feb 20, 2016.
Tony Featherstone is a former managing editor of BRW and Shares magazines. All prices and analysis at February 21, 2017.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.