Description
Brambles is by far the #1 global market leader for pooled pallets. Listed on ASX, EV of USD c. 13bn, trading at ~7x '22 EBITDA.
Note: they have an ADR, which has a lower liquidity, I am discussing
BXB.AX listed on ASX.
Brambles in 2021A printed USD $5.2bn sales, and $1.6bn EBITDA for a 50% margin. In 2022E they have guided to a $5.6bn sales and $1.7bn EBITDA for 20% margins, largely due to the effect of recent lumber price spikes, but that should abate and going forward they should benefit from lumber price declines and relative shift to wooden vs plastic pallets (see below).
Brambles is a pool operator of returnable packaging solutions (focusing on wooden pallets), for the F&B and FMCG end markets (USD ~7bn replacement value)
Brambles has strong quality characteristics, exhibiting very clear market leadership, strong barriers to entry and provider of an essential service for efficient supply chains with strong ESG traits.
Why the opportunity? The share price has basically traded flat over the last 5 years (despite strong public equity markets) due to limited FCF growth and focus on simplifying the business, creating an opportunity for a catalyst by way of a take-private once capital markets reopen, plus FCF catalyst as growth capex has been expended for FY2022 and temporary depressed FCF levels abate.
Company Description
What is pallet pooling? They basically provide returnable packing solutions and supporting equipment to store and move products through supply chains, primarily in the FMCG and F&B industries. They operate the largest pool of resuable wooden pallets through the CHEP brand.
They are global, and operate in APAC (47%), EMEA (41%) and Americas (11%). By product, > 90% is wooden pallets.
Pallet business models
There are essentially 3 ways to manage pallets, ranging from one-way (least integrated), rental/public pool (which is where Brambles operate) and closed loop/private pool (most integrated).
- Rental, public pool (Brambles): Rental supplier (pooler) owns and manages pallets, with customers paying on a variable basis, and may include inspection, maintenance and return logistics.
- One-way: Pallets in this system are purchased by initiating party for one-time used, typically "white-wood" or lower quality pallets which are disposed of or recycled after initial use. This is more prevalent in US, Europe or developing markets that are more fragmented
- Closed loop, private pool: This is a rare model which requires the operator of the closed loop pool to have significant scale and vertical integration, and only for small number of scaled players like Coca-cola
Within the Rental, public pool, there are two rental models:
- Daily fee (more profitable, pre-dominant in APAC): The daily fee is charged to the party who is currently holding pallet, incentivizing timely returns, Brambles is paid while pallets are not re-issued, enhancing utilization
- ROIC in APAC is >25%
- Enhanced by rational duopoly between Brambles (75%) and Loscam (25%)
- Trip based (less profitable, usually in EMEA and Americas)
e-Commerce disruption risk and mitigants
e-Commerce has some disruptive impact of reducing the use of pallets between a retailer's distribution center (DC) and retail store, by going direct from DC to end customer, and reduces stickiness in the supply chain by simplifying the pooling ecosystem. This is however mitigated by the fact that it does not eliminate the palletised leg between the manufacturer and DC, the last mile leg to retailers is less profitable, the fact that Brambles has grown 5-7% in the last 5 years despite e-Commerce growing the most during this time, and should benefit from logistics support for transport to and from DC.
Wooden vs Plastic Pallets - Discussion
There a risk of a broader trend towards plastic pallets which offer better durability, automation, hygiene and trackability. These risks are overblown, and there are many mitigants and evidence pointing towards continued wood pallet dominance (currently the most common solution (~95%) of total pallets, of which 60% are non-reusable and in-house pallets, 20% are pooled and moving pallets - the market that Brambles operate in).
- Cost/Price is by far the #1 KPC for pallet solution given commodity nature of product: While less durable than plastic (20-50 trips vs plastic at 100-250 trips or 10-12 years), wooden pallets are much more cost efficient from maintenance and price point. On maintenance, wooden pallets are easily repairable, vs plastic which are more costly to repair and has to be cleaned after each rotation(although damage factor of plastics is 1/10 of wood). On price point, in normalized times, plastic pellets are 3-5x more expensive than wood. Today with inflation, cost of manufacturing plastic pallets have jumped >50% in 2022 due to oil / polyethylene input costs spiking from the Ukraine war, and abating lumber prices in the U.S., and now the cost of plastic pallets is now 4-5x a wooden pallet (50% higher than 12 months ago), loss rates are lower for plastic (30-50%), but this is only because they are usually deployed in trade lanes that experience less losses.
- ESG: While this can't be clearly valued, wood pallets obviously have better environmental traits than plastic pallets, which are highly relevant for companies seeking to operate with a sustainable supply chain and have better circular traits.
- Track record of growth: Brambles has grown sales CAGR at >6% L5Y, and EBITDA margins have been consistently 50-55%, highly profitable business and reflection of their high teens ROIC. 2021 EBITDA margins were >30%, although FCF was impacted by growth capex to serve customers (and in turn impacted by lumber cost inflation, but that will abate in FY 2023, as seen in lumber prices).
Plastic pallets are fast growing, but a large majority of their growth is in the upstream (manufacturing environment) where companies like Contraload operate. Brambles focuses on downstream, where pallets are largely used for delivery and where factors like durability and hygiene play a less important role than price (more commodity product). In Europe, although CHEP (Brambles branded business) also has around 20-25% market share (Contraload has 25-30% market share), both companies rarely face tenders against each other, and the majority of CHEP's business is in downstream (3m vs 1m upstream).
Costco Customer Discussion in U.S.
One key recent update is that 1) Costco has decided to move towards plastic pallets in 2019, and while Brambles had been undertaking a comprehensive trial for plastic pallets (investing $20m in trials; but this is mitigated by the continued use of the plastic pallets developed under this program), they have announced that they will not go ahead with transitioning to plastic pallets for Costco. This is somewhat of a blow as Costco is one of Brambles fastest-growing retail partners (CAGR of 13% over last 5 years), representing c. 10% of US pallet volumes. That said, the mitigant is that Costco presents 10% of US pallet volumes (that is <$20mm EBITDA impact off a ~$1.7bn EBITDA company, so the total impact should be minimal at group level).
Dropping plastic pallets is a rational decision. Trial discovery showed that a Costco plastic-pallets program would yield <10% ROIC (average ROIC of Americas business is 15-16%, group level of ~18%). In addition, plastic pallets are usually only suited to dedicated pools serving one customer, low loss supply chains supported by EFID tracking and requires a price premium over wood pallets, likely preventing broader adoption within the wider customer base (although the downer is that having greater expertise in plastic pallets can be an entry ticket into newer and more attractive customer segments in pharma, semiconductor etc.) Expansion into plastic would cannibalize Brambles core and more lucrative wooden pooling business.
In fact, when Brambles announced that it was giving up the plastic program in June 2022, the stock rallied to >10x EBTIDA valuations.
Growth
Brambles has been growing its revenues between 5-7% annually since 2016 (and FY22 grew 9%, profit increased 10%), and we expect similar growth rates in the hold period. This is driven by underlying market growth of 4-5% volume, 2% LFL price increases per annum, and 0-1% new wins.
Volume growth is driven by pallet growth of underlying end market of transported goods, most important sub-sectors being FMCG and F&B which are relatively stable demand driven by population growth and consumer retail spending. More importantly, there is increasing pooling penetration driven by 1) conversion of non-palletized flows (safer to use pallets), and 2) when using pallets, value proposition of renting vs. owning is clear given a) lower capital intensity, b) lack of maintenance needs c) consistent quality from regular inspection and repair leading to lower safety risk and product damage d) flexibility to adjust usage as a result of network availability granted by pooler.
2% LFL price increases are underpinned by their contracts which usually provide for annual adjustments of prices for cost inflation (important in this inflationary climate which would boost revenue (although also affected by inflation in their cost base). At contract extension, prices are re-set which provides Brambles opportunity to demand further price increases in case of favorable market situations, like now - supply chain crunches.
Net new wins are likely, as Brambles is the dominant player benefitting from network effects vs sub-scale competitors and low churn, but it is not necessary for the base case.
Value creation - 1) Continued Operational Efficiency Initiatives, 2) Right Sizing Cost Base, 3) Carve out APAC as Standalone
Brambles have continued to improve pallet durability, leading too 100bps reduction in damage rates (25bps ahead of annual target), and have continued to optimize network and piloting partially automated repair capabilities. They have also further improved their collection ability, allowing them to recover 2.5mm pallets during FY22 (they manage 345mm pallets, so just 0.7% of pallet base), and installed pallet re-manufacturing capabilities, re-manufacturing 1.5mm pallets in FY22 at higher incremental margins.
In conjunction with the above, there are also two promising digital initiatives: Targeted and Continuous Diagnostics: the basically inject a tracking device (like an AirTag) into their pallets, to refine their asset base, which has two benefits 1) to optimize asset quality e.g. can use a higher quality wood for certain types of products and 2) improve asset collection, recycling and tracking, which has led to >$50mm in savings plus new charging of pallets on routes that they were previously not getting paid for.
More importantly, pallet pool businesses are localized business, and there is little logical reason why the business should combine 3 distinct geographic reasons. This has a couple implications
- There is a large group corporate overhead which overlaps with regional operations
- Potential multiple/value arbitrage by selling the APAC business which should trade at a significant premium from better business model and market leadership
- The clearest comp is Goodpack, #1 market leader in IBC pallet network operator serving rubber end markets, with EBITDA just under 50% and having 16% unlevered IRR unit economics
- KKR took private Goodpack in 2014 for LTM 12.0x EBITDA and 13.7x LTM EBIT, for an asset with lower unit economics, lower growth, and higher cyclicality (transports mainly rubber, tire end market)
- There is attractive growth from penetrating large SEA economics leveraging the market leadership in Aus/NZ
- KKR is also the most likely buyer as they have a $4bn Asia focused Core+ infra fund, in addition to their $15bn Asia PE Fund
- The 2-3 EBITDA turns of value (~$1.6bn - $2.4bn value, 8-13% of incremental TEV valuation) is hidden under the conglomerate discount
Clean take-private candidate
They have been listed on ASX since 2001, no strategic shareholders and head office is based in London.
Potential separation into three distinct regional businesses (APAC, EMEA, Americas) due to limited synergies across regions; opportunity to right-size cost base • Clear angle for commercial (e.g., business model and go-to-market approach in the US) and operational improvements (ops efficiency, asset control, digitalization).
Investment Thesis
Thesis
- By far the #1 provider of pooled wooden pallets, with >70% market share in most of the markets they operate in.
- Downside protection evident from:
- Over 80% of sales are generated from the consumer staples sector, underpinning resilience
- During GFC in FY09 and FY10, sales was broadly flat while capex spend fell ~$180mm each year
- Low churn rate
- Geographical diversification, operating in >60% countries
- Many customer contracts include input price pass through clauses, mitigating inflation (in FY2022 the cost-to-serve increased by $430mm largely from plant inflation of $180mm and transport inflation $200mm but this was completely mitigated by price and surcharges.
- Essential part of supply value chain
- Frequency of use and low % of customer COGS (typical average daily hire rate per pallet of $0.05)
- Strong market growth from ~5% volume, 2% price increases as discussed above
- Attractive unit economics - Generally closer to 25% for APAC and EMEA, and closer to 15% for Americas
- Take-private
- Downside protection from asset backing
- ESG angle from circular economy and asset sharing, with wood as the more sustainable option vs. plastic
- Risk of pallet capex inflation - >$600mm in FY2022 is one-time and largely mitigated by recovery of U.S. market timber pricing (2012-mid 2020 was largely in the $200-400 per thousand board ft range, mid2020 to Q1 2022 mostly in the $800 to $1500 range, but has since traded down to $410 today.
- NB in FY21 they printed 622 FCF from $1.7bn EBITDA, but today $86mm FCF from $1.85mm EBITDA, the delta is largely explained by the $470mm pallet price inflation
- The other $150mm increase in pallet capex is also one-time in nature, from icnrease dcycle time and replacement of lost pallets
- The European business however likely to suffer, as timber is 2-3x historical price exacerbated by the Ukraine war
Valuation / Investment Case
Shares outstanding: 1.39bn
Current SP: 12
Current Market Cap: 16bn
Total Debt: 2.88bn
Cash: 158.2m
Net debt: 2.73bn
TEV: $18.73bn (FY2022 EBITDA = 10x, FY2021 EBITDA 10.7x)
FY2022 EBITDA: $1.85bn / FCFE: $86mm
FY2021 EBITDA: $1.74bn / FCFE: $341mm
Large increase in capex of $600mm due to lumber inflation on pallet purchases, but this is one-off and should revert (just look at lumber chart)
Capital structure is healthy: Net debt/EBITDA at 1.47x, and net interest coverage is at 21x
Assume a business as usual, with growth at 6%, EBITDA margins at 30-32% and EBIT margins at 16-18%, maintenance capex remaining at ~15%, and growth capex at 2% , assuming no multiple expansion we should yield >10-12% with inflation abating, with a potential upside from a take-private scenario to unlock the conglomerate discount. You also get paid 2-3% dividend yield while waiting.
I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.
Catalyst
Take-private + breakup to unlock conglomerate discount
Abating lumber inflation + FCF recovery
Strong fundamentals driven earnings growth and deleveraging