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Morningstar | Brambles Beginning to Look Fairly Valued Following Fiscal 2018 Results

Wide-moat Brambles' full-year results reflect continued inflationary pressures that kept a lid on substantial profit growth. Underlying net profit after tax of USD 656 million tracked our forecast for USD 636 million, up 7% from the prior fiscal year, trailing revenue growth. But we remain positive on the firm's long-term opportunity. We're encouraged that the company saw continued volume gains, improved new-business wins, and pricing actions that helped to partially offset transport and lumber cost inflation, and expect further profitability improvement long term as contract renewals and pricing mechanisms flow through on a lag. Management also flagged plans to divest or sell the IFCO reusable plastic crate, or RPC, business, although this has no impact on our valuation, given the independence of the segment, the uncertainty around the potential form of the transaction, and the lengthy associated timing in fiscal 2020. We retain our AUD 11.20 fair value estimate, and after increasing more than 6%, shares in Brambles screen as roughly fairly valued.

CHEP Americas increased revenue by 6%, outpacing our 4% forecast. Offsetting this, rising costs and a time lag between price increases led to expenses growing more quickly than anticipated, with underlying operating margins of 16% slightly lower than the 16.5% we projected. Underlying profit of USD 351 million slightly trailed our USD 356 million forecast. Management expects cost pressures to continue, offset by operational efficiencies and lagged pricing surcharges.

Plant automation remains a focus for the CHEP Americas business. Brambles plans to spend USD 150 million-USD 160 million in the three years starting fiscal 2019 to lift levels of automation in the U.S. business to 85% from around 20% currently, which we expect to spur 300 basis points of EBIT margin improvement by fiscal 2022. The European business is already 80% automated.

Outside the Americas business, CHEP EMEA growth was strong, climbing 16%, substantially outpacing our 5% forecast, with margins of 24.9% similarly higher than our 24.5% assumption for the full fiscal year. Amid flat pricing in pallets, growth was principally driven by increased volume and foreign currency movements, along with strong performance in the RPCs and containers businesses. We still forecast mid-single-digit revenue growth from the segment over the next several years, but steady margins, given the already high level of automation and solid profitability in the segment.

CHEP Asia-Pacific was a bit weaker, with sales falling 2%, a bit more than our forecast for a 1% decline, as Australian RPC and automotive contract losses from 2016 continue to roll through the top line. We expect this business to return to growth in fiscal 2019, however, and are encouraged that outside of the contract losses, sales grew 3%. Moreover, the segment's 23.5% operating margins are in line with our long-term forecast.

IFCO's revenue grew a solid 13%, ahead of our 11% forecast, with positive pricing leading to 12.4% margins, above our 12% expectation. Although we're impressed by the division’s continued solid volume growth and operating leverage, management has outlined a plan to divest or sell its ownership of the IFCO RPC business by the end of calendar 2019 (which would put the transaction in fiscal 2020). We had anticipated a strategic review of IFCO's North American business, given the profitability challenges experienced there, versus solid growth in Europe. But management has outlined that there is no meaningful operational overlap or customer synergies between CHEP and IFCO across any of the segments, and the businesses would be better run separately. Highlighting this point, RPCs are focussed on fresh and perishable items, versus Brambles' pallet business, which focusses on consumer goods.

IFCO was originally purchased in November 2010 for around EUR 1 billion, or approximately USD 1.3 billion at prevailing exchange rates at the time, but never fully integrated the business with the legacy CHEP segments. In fiscal 2018, Brambles divested CHEP Recycled, which partially comprised IFCO's whitewood pallets business, and separated IFCO's remaining RPC business, which operates in Europe, North and South America, Japan, and China, into a separate reporting segment at the fiscal 2017 results. Our preliminary assumptions indicate IFCO could have an enterprise value of close to USD 2.8 billion, implying a trailing EV/EBITDA ratio of around 11 times, and comprising 18.5% of the combined group's EV at our fair value estimate. However, we continue to forecast the consolidated financials of both Brambles and IFCO, as further details on the transaction, including potential capital structure, are yet to be determined. Brambles intends to retain its RPC businesses in Australia, New Zealand, and South Africa.