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Brambles changes tack on plastic pallets

Jun 03, 2023


Supply chain solutions company Brambles has made an important change to the return on capital required from any new investment in plastic pallets in the US.

The March-quarter update from global supply chain logistics group Brambles was just the tonic needed for a stock weighed down by concerns of a possible $950 million unsustainable expansion in the United States.

Chief executive Graham Chipchase sent a strong message to the market that he would not proceed with the costly move into plastic pallets for Costco unless the deal jumped a significantly higher hurdle for return on capital.

Brambles chief executive, Graham Chipchase, seems to have listened to shareholder concerns about expansion in the US. David Rowe

This message was contained in the following two paragraphs in the quarterly update: "Our plastic pallet trials with Costco are ongoing, and we remain on track to make a decision by the end of FY22.

"Any investment in plastic pallets will only be made if returns are not dilutive to group ROCI after an initial ramp-up period and will be subject to ongoing review as part of the group's disciplined capital allocation process."

What Chipchase did not explicitly say was that he had significantly changed his hurdles for the business, something that was quickly picked up by investors and fund managers.

It would seem the company has responded to pressure from shareholders including Perpetual which earlier this month made clear its concerns about the plastic pallets expansion.

This revelation on the changed capital return hurdles partly helps explain the surge in the Brambles share price. The other factor behind the stock rising by 8 per cent to close at $10.82 on Thursday was the upgraded revenue and EBIT guidance contained in the quarterly update.

Jarden analyst Jacob Cakarnis spelt out the company's apparent changed position on plastic pallets in a note on Thursday.

"The key overhang for the stock, in our view, remains the plastic pallets investment decision," he said.

"Following this release, there is no further detail regarding the progress of the plastic pallets trial. The company remain committed to their decision date ‘by the end of FY22E’ provided returns are not dilutive to group ROCI (1H22: 18.8 per cent) which seems to be higher than the initial decision conditional at 10 per cent to 15 per cent ROCI.

"We estimate that the plastic pallets investment decision could result in net capex of $US600 million to $US700 million phased over two to four years.

"We think the outstanding questions for investors remain: 1) duplication costs ⁄ impacts on existing lumber pallet pool; 2) contagion risk potential for other customers transitioning to plastic pallets; and 3) extent of capex required and ability to profitably re-issue returning lumber pallets."

Brambles later confirmed to investors that it is using a ROCI of 17.6 per cent for the pallets investment decision.

Paul Skamvougeras, head of equities at Perpetual said he was pleased the ROCI hurdle rate had been changed.

"However, we struggle to believe it is achievable given the current cost of plastic pallets, likely loss and damage rates, as well as tolerable rental rates for its customers," he tells Chanticleer.

"We fear that if such an investment was to go ahead it would be under false pretences and ultimately be dilutive to shareholder returns.

"Even if it is achievable, we wonder why the Board thinks 18 per cent is an appropriate ROCI given the risks of investing in plastic pallets are so much greater than wood?"

Skamvougeras says the stronger than expected third quarter sales and profit upgrade were a testament to the strength of CHEP's pooling model.

"We think further price realisation to cover CHEP's higher cost-to-serve in the Americas is warranted," he says.

"In our view, it's critical that the Board and management take advantage of the current unprecedented tightness in pallet markets and continue to raise prices to address the fact free cashflow yield in the Americas remains well below its cost of capital."

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Tony Boyd