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Brambles Share Discussion Threads
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|Anyone following this company or looking at investing should buy into this stock,|
|active thread ! looks like BXB about to turn up in oz after correction !|
|on nice short term uptrend in OZ but such a wide spread here in UK and thinly traded ! A pity that MMs are not made obsolete !!|
|Brambles has a terrific business in CHEP, but is it good enough to justify the stock's outlandish price tag?
I've struggled with Brambles for years, but never more so than in the past few months. I first came across the company (or rather its pallet-pooling business CHEP) 12 years ago, while researching the UK engineer GKN (then a part-owner of CHEP) as an analyst in London. I liked the look of the business, but GKN was quite pricey and CHEP was only so much of it, so I didn't buy any. In 2001, when Brambles listed in London, I bought some for a fictional share portfolio I was running for my then employer The Motley Fool UK, but I had limited spare funds at the time so I passed for myself.
Of course, Brambles repaid my faith by losing 15m pallets in Europe and about 40% of its profits. Some of the numbers coming out of Europe had been a bit funny ahead of events and many people had seen the trouble looming, but not me so I felt somewhat chastened. That's why I missed the golden opportunity the stock offered up in the wake of the fiasco.
Since then, CHEP has gone from strength to strength and Brambles has made the right corporate moves by selling off its lower-quality divisions. Observing this success without participating in it has been getting a bit much lately, so I've been getting a serious itch to finally buy into the company. But am I too late for the party?
Icons of global trade
Well CHEP, which now contributes 88% of Brambles' profit, certainly has a lot going for it. Containers and the huge ships that lug them around are the icons of global trade, but they wouldn't get very far without the humble pallet. Pallets are how goods move about. All you need is a flat area and a forklift truck (or even just a simple jack) and you can do what you like with them. These days, goods are taking an increasingly circuitous route to get to consumers, as specialist factories in a variety of locations perform different tasks. The future for pallets is as bright as the future for trade.
But pallets do have a big drawback. Each one costs tens of dollars, depending on quality, and that might be a significant chunk of the value of the whole package. So each link in a supply chain will either have to return the pallets to the previous link, or buy them along with the goods and hope to sell them on to the next link, or account for them in some other way. But people have enough to argue about with the goods they're trading, without having to worry about the pallets. So what's the solution? Well the trick is for everyone to get their pallets from one big pool and pay for their slice of the usage (ie the opportunity cost of the capital tied up in the pallets, the cost of moving them around and some wear and tear).
CHEP runs the biggest pool of pallets there is, and in doing so it takes a huge weight off everyone's shoulders. Where the business particularly adds value is where its customers use the pallets between themselves in trade networks, because the pallets can flow through the networks together with the goods, thereby cutting the cost of returning them or otherwise accounting for them every step of the way.
And CHEP can combine its customers to extend these networks. If a store in the US sources its goods along a supply chain originating in Malaysia, for example, at the end of their trip CHEP might pass the pallets on to a local US customer which is shipping goods back to Malaysia thereby removing the cost of the pallets making the return trip empty. The greater the number of businesses involved in CHEP's networks, the more useful and entrenched they become.
These 'network effects' are legendary in communications. Robert Metcalfe, founder of US networking infrastructure group 3Com, once said (in what has become known as 'Metcalfe's law') that the value of a network increases in proportion to the square of its number of users, because not only can each new user make connections with all existing users, but all existing users can make connections with the new user. A simple telephone network is a good example, as is the online auctioneer eBay.
Now pallet pooling isn't in this kind of networking league, because users can't just make connections with everyone else; you can't, for example, sell tinned anchovies to a manufacturer of car exhausts. And much of CHEP's business involves simple pallet collection and exchange services rather than entire supply chains. But in a complex trade network, CHEP can add a lot of value, and once it's built into the network it's hard to shift.
The level of quality that you ascribe to CHEP's business will depend on how you perceive the strength of these network effects, now and in the future, and the extent to which you think it has the future market sown up.
Clipping the ticket of world trade
At the moment, CHEP is easily the world's largest pallet-pooling operation, and crucially it has been building up a serious head of steam in the North American market recently. But the battle probably isn't quite won yet. The market is still highly fragmented. For example, it's estimated that there are currently about 2 billion pallets in use in the United States alone, and CHEP only has about 270 million in the world.
But CHEP is firmly in the box seat. It would take a huge investment from someone else to match it, with no guarantee of success, and if they did draw level with or pass CHEP, they'd find a more competitive and less attractive market when they got there, simply by virtue of their own participation.
So the bull case for Brambles is that in a few decades' time CHEP will be irreversibly entrenched in the world's biggest and best trade networks, effectively enabling it to 'clip the ticket' of world trade. And because its business would stretch across so many borders, there'd be little any national regulators could do about it.
I can feel myself getting overexcited. To calm things down, let's take a look at the bear case. We've already touched on one of the biggest problems the business faces, which is that people don't want to be arguing over pallets, but if CHEP is to save them from that, then it has to end up arguing with everybody itself.
The reason the company got into trouble in Europe was that it was growing quickly and its executives were incentivised to keep that going. This meant they were more interested in supplying pallets than they were in getting them back in one piece. But after employee costs and transport, CHEP's next largest business expense is the wear and tear on its pallets, and ignoring it proved a very costly mistake.
Recall good not great
Outgoing chief executive David Turner has met this problem head on by changing the way CHEP incentivises staff (focusing on return on capital rather than simple sales growth) and by trying to hold customers more directly to account for damage and losses that occur on their watch. Mike Ihlein, currently chief financial officer, who will take over as CEO on 1 July, comes with a big reputation and will most likely continue to apply good discipline.
But this doesn't change the fact that CHEP's assets are spread far and wide across the planet, and they're in the possession of people who don't care much about them. This makes it a very tough business to manage, and the increasing complexity of trade networks (which we saw as a plus point just moments ago) is only making life harder. On the plus side, RFID tagging should make it easier to keep track of pallets. But even so, there's every chance that CHEP will drop more woopsies in future.
Of course Brambles does have another division. Recall helps customers manage the storage, retrieval and eventually the destruction of their documents and other information. The focus is on 'transaction-intensive market segments' such as banking and finance, insurance, and government which have a regulatory need to store a lot of information.
It's a nice business, making an operating margin of 17% in the 2006 financial year, but it doesn't have the inherent strengths of CHEP and it doesn't deserve to be valued on the same multiple of earnings. So the overall price you'd pay for Brambles needs to be tempered a little by this.
Which brings us to the last, but certainly not the least, point on the bear side of the equation: price. Brambles should earn around 46 cents per share in the current year, which puts the stock on a PER of about 30.
Now with some of the PERs being bandied around the market at the moment, that doesn't seem out of place for a high-quality growth stock. But as Greg mentioned in his feature article last week, Can you tell a stalwart from a sluggard?, seeing too many high PERs can make you a bit blasé. The fact is Brambles chartthat a PER of 30 is very high by any normal standards and, to give it further context, it's even higher than that of eBay, which we mentioned earlier (and which currently sports a PER of 26).
At these levels, there just doesn't appear to be quite enough margin of safety for what is an accident-prone business, even if a very good one. There was margin of safety galore after the last hiccup in 2002, but I missed that opportunity and buying now won't bring it back.
Perhaps this gets to the nub of my problem: part of the reason I want to invest in Brambles is that I think the company might do really well in coming decades and, having looked at it so much, it would be extremely annoying to miss out. But giving in to the fear of missing out is one of the most dangerous mistakes an investor can make.
Brambles probably will do well in coming decades, but that doesn't make the investment equation a good one. It is, however, a very high quality business and it deserves a premium rating: we'd be very interested if the value equation improved. Here's hoping. In the meantime, if you own the stock, we recommend that you HOLD.
|these shares have done well over the years for me, bought in at £1.38 plus had some good dividend returns, still holding|
|Results looked solid to me.|
|Ok, its an unexiting industry chaps, the world of pallets and food supply, but in this world CHEP is king. CHEP is a strong brand and is presently preoccupied with world domination. With new markets to plug into and a proven business model growth looks assured over the medium term.|
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