First, it is a relatively complex industrial company, with operations all over the world with many nooks and crannies where a clever private equity manager hopes to find profit pools.
Second, Brambles has a piece of infrastructure that the private capital markets love. Its roughly 350 million wooden pallets are part of the global trade plumbing, as we discovered amid last year’s epic pandemic supply chain disruptions, it becomes very difficult to move goods from factories in the world to stores in the world when pallets are scarce.
Persistent underachievement
Third, there doesn’t seem to be a shortage of options for a private equity buyer to explore in terms of corporate restructuring. The most obvious is a sort of regional break, where a combination of American, Latin American, European and Asian companies are listed for sale.
And finally, and perhaps most importantly, Brambles has always been an underperformer from an investor perspective.
While analysts almost universally appreciate the group’s competitive position, it is dismaying that the scale advantages it enjoys as the world’s largest provider of pallet pooling services have failed to be reflected in the operating leverage. This was the case even during the pandemic shopping boom, when price hikes imposed by Brambles were generally disappointed.
The stock underperformed the S&The P/ASX 200 index is up 8% over the past 10 years and 22% over the past five years. It basically moved sideways for 12 months.
Tensions between shareholders and the board of directors have increased, with Perpetual’s head of equity, Paul Skamvougeras, raising the most important questions about the group’s strategy. Skamvougeras has become one of the ASX’s most prominent campaigners in recent years, and Brambles joins Crown, GrainCorp, Tabcorp and Link as companies he helped set up.
The biggest point of contention between the market and the board has been Brambles’ review of a plan to replace the wooden pallets it supplies to US retail giant Costco with plastic pallets, which are more durable and easier to track, but also more expensive.
Opinions are divided on the project. Some, like RBC analyst Owen Birrell, see it as a necessary investment in an industry where conversion to plastic pallets will become more common. Birrell believes this will allow Brambles to pursue a “more efficient ‘closed loop’ operating model that takes advantage of pallet durability and a reduced need for repair, maintenance and transportation”.
But others, like Skamvougeras, argued that the cost of the project, between $450 million and $700 million, would mean Brambles is throwing good after bad at its U.S. business.
Critics were particularly concerned with Brambles’ initial target for a return on investment from the project of between 10 and 15%; while this was consistent with Brambles’ US operations, it was below the 18% return on investment across the group.
After Skamvougeras slammed Brambles’ Costco plan – arguing that based on free cash flow the U.S. company wasn’t even covering its cost of capital – the company announced last month that it would not ‘before if she could reach ROIC in line with the larger group, about 18 percent.
This would seem to put the project on the razor’s edge; with soaring resin prices making plastic pallets more expensive, achieving an 18% return on investment could be difficult. Even proponents of the Costco project, like RBC’s Birrell, think it will likely cost around $1.1 billion.
The Costco project – whose decision is expected next month – perfectly illustrates the crossroads where Brambles finds itself.
Management has a plan to reinvest in the business, but after 10 years of underperformance, it seems the confidence of many shareholders and the market in general has run out.
While CVC offers an attractive price, investors seem inclined to let private equity tackle the hard work of reinvestment, away from the ASX’s brilliance.
As always, everything will depend on the price. Shares of Brambles jumped 11.2% yesterday to close at $11.60, but a 25% premium to the stock’s closing price on Friday would suggest a price above $13. The stock stood at $12.90 in February 2020, just before the pandemic panic hit.
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