Global logistics giant Brambles is on track for increased margins in the longer term despite posting a 3 per cent dip in underlying profit, says Morningstar.

The pallet maker, which carries a wide moat – or sustainable competitive advantage – posted a result that was largely in line with the expectations of Morningstar analyst Adam Fleck.

The company posted an underlying profit of just under US$504 million for the first half of FY2019, down 3 per cent year-on-year from US$513.4 million, when adjusted for currency changes.

However, group revenue rose 7 per cent to US$2.85 billion on a constant-currency basis, as Fleck had expected, having looked for mid- to-single-digit growth.

"We’ve lowered our near-term projections, but we think the firm’s longer-term opportunity for margin expansion remains, owing to further pricing actions, more modest cost inflation, and investments in automation and other cost savings," Fleck says.

Rising costs of transport and timber led to a 3 per cent fall in operating income, as costs increased to US$2.43 billion.

A forklift in a warehouse

The CHEP pallet business in the Americas took the biggest profit hit

"They generally try to pass these on to customers, and they've done a good job of that in Europe," Fleck says. He indicates Brambles is improving its cost recovery within other key markets in the Americas and Asia Pacific.

"The resulting drop in margin, which was down 17.7 per cent, trails our prior forecast for flat full-year profitability.

"And management’s outlook for underlying profit to only modestly grow this year is a bit worse than we had expected," Fleck says.

Brambles' US$319.8 million net profit after tax for the half was down 25 per cent from the same period 2018 – on the back of cost rises and the loss of a US$103 million tax benefit incurred a year earlier.

The logistics company's CHEP pallet business in the Americas took the biggest profit hit, down 11 per cent during the half despite a 5 per cent contribution from higher prices.
Fleck expects margins will improve in the medium-term as newly signed contracts better reflect higher operating costs and rising inflation, and automation reduces costs.

"We now see margins in this business falling to 14 per cent in fiscal 2019 versus 16 per cent previously, but still see this metric climbing to 20 per cent by fiscal 2022," Fleck says.

Mobilising against Brexit threat

In the second of its largest regions, Brambles' European business also fights inflationary cost pressures, though these are less pronounced than in the US. Margins here fell just 0.7 per cent, in line with Morningstar's forecast of 24.4 per cent for the half and on track to reach 25 per cent by year-end.

However, continuing uncertainty around Brexit could weigh on Brambles' near-term revenue and cash flow in Europe – specific risks include timber supply, falling demand and labour shortages.

With about 10 per cent of the company's European volumes exposed to Brexit concerns, management revealed it has created a taskforce and been planning for various scenarios.
Brambles has already spent US$11 million in boosting its inventory of pallets ahead of a potential UK separation.

"We forecast mid-single-digit annual revenue gains and flat profitability over the next several years, but worse macroeconomic conditions could drive operating income 8 to 10 per cent lower than our base case by fiscal 2023, by our estimate," Fleck says.

Management also confirmed on Monday it expects to spin off its IFCO reusable plastic container business during 2019, as previously announced in August, though the process is not finalised. IFCO contributed around 20 per cent of group revenue in fiscal 2018.

Fleck maintains his fair value estimate of $11.20 on the result.

Brambles' shares were trading at $11.045 at 3:30pm, up from $9.63 a year ago, but down more than 18 per cent from a 12-year high of $13.45 in August 2016.