Joseph Taylor: So the ASX is home to quite a few niche industry leaders, you could say. We've got WiseTech in logistics software. We've even got BHP, one of the world's leading iron ore miners. Today we're talking about Brambles, who are, you could probably say the undisputed king of pallet pooling. What is pallet pooling?

Esther Holloway: Yeah. So, we all use products every day that are carried on those wooden pallets. So, it's a few pieces of wood, criss-crossed, and the goods are racked on that. They're shipped, they're moved around in trucks. Basically, everything we buy has touched a pallet. So, pallet pooling is the system where rather than a business owning the pallet and sending it from A to B and then retrieving it and bringing it home, they rent it. So, Brambles takes care of the logistics in terms of once I get it to you, they'll bring it back and they'll repair it and then I can borrow again from them.

Taylor: The pallets themselves, I think it's hard to think of a more commoditized product. It's just a few pieces of wood, some nails. What about the business model makes it moaty?

Holloway: Our Wide Moat rating is on cost advantage. And that's from scale. So, Brambles really has the greatest market share in most of its geographies in pallets. So how we think of the scale is the more customers they have, the more service centers they have and the less distance they have to travel between their customers. And the more customers they have, the better scale they get from route optimization of how they go and pick up their pallets and bring them back. Because obviously the fuel to run around and pick up all of these things is a cost. We think they have a cost advantage in reducing that distance.

"It's about time in the market... the longer they're there, there more market share they gain"

Taylor: You touched on their dominance in their key markets there. Australia, the U.K., maybe even North America. Where does the growth come from in terms of regional growth?

Holloway: Yeah, so that's an interesting one. It really is about time in the market for these people, for this company. So, they've been in Australia the longest and we think they have about 99% of addressable market share. So, there's not a lot more growth we can expect there in terms of new business. But then you've got the U.K. and the U.S. where they haven't been there as long and we can see that the longer they're there, the more market share they gain. So, it's just about word of mouth, about communicating the benefits of pallet pooling, about people understanding it and that scale advantage. As they get more stores, they can offer that through scale to their customers and better service. Africa, Middle East, are all areas where they've got a lot of opportunity. Even China, they have a slither of the piece there. But we all know the population and the size of China, even having a bigger slither is still very good growth.

Taylor: So, in these markets where Bramble's is already established, I think a key part of the growth forecast that you've talked about in your research is pricing and margin expansion. How does that come about?

Holloway: Yeah. So, at the top line, it's really quite straightforward. It's a combination of price and volume. So, price, they have pretty robust contracts. They vary by geography, but generally they can claw back price and CPI type price increases. And then volume is a combination of just awareness in the market and gaining new customers who otherwise would have used alternatives such as owning your own product, which we call whitewood, and then the new business growth from emerging markets.

"I have very strong opinions on where the operating margin growth is going to go"

Taylor: So, you've raised your Fair Value estimate for the stock twice recently, and a lot of that is to do with improving margins. Do you want to speak a little bit about that?

Holloway: Yeah, you're right. So, since I initiated on this company in May, I've increased the fair value by about 50%. So very significant. I have very strong opinions on where the operating margin growth is going to go. And I've increased that on two occasions now. So initially, I looked at that and most companies tell you that they're going to do something. Often, they tell you it's going to be digital and it's going to have an improvement. In this case of this company, not only did they do it, but they really blew it out of the park. In their earnings result, they had almost 200-basis-point increase in operating margins. They're introducing robots into all of their factories and warehouses to repair the pallets, which reduces labor costs. And then there's a series of other little operational and hygiene type things they're doing that are really helping to grow that operating margin while we have that steady revenue, which is quite strong as well.

"It would be a huge shift for the world to suddenly start using a future technology."

Taylor: So, your fair value estimate is still a fair bit above the current share price. What do you see closing that gap?

Holloway: That's an interesting question and one that I speak to with my colleagues and with clients quite regularly. They say, well, wood is such an old technology. Surely, it's going to be displaced by something else. How do you know there's a future in this? It's a very basic product, but it's one we use every day. It hasn't had great need for innovation. They're still gaining market share. We've got the records of that. We can see that the world – the top companies in the world are not creating their own solution. They're happy to use this product and the supply chain and warehousing is built around the use of pallets. So, it would be a huge shift for the world to suddenly start using a future technology. Not saying it wouldn't happen, but I think we would get a line of sight to that happening and that coming along. For instance, they've looked at plastic. So, they looked at using plastic and the economics just are not there. It costs a lot to have resin. It's a product from oil. So, it's just not there to use an alternative product to do the same job at the moment. We'll see.

Taylor: I guess it's not really all about the pallets either. It's about outsourcing.

Holloway: Yeah. Well, that's a great business model in itself. I mean, it's just – for a company – that's sort of how these guys grow their business is as a company gets so big, they can't be going and picking up a pallet and arranging for having someone in their office who hammers it back together as it breaks.

Taylor: Thank you very much, Esther.

Holloway: No problem.

Brambles (BXB)

  • Moat rating: Wide
  • Fair Value estimate: $22.00
  • Share price October 8: $18.85 
  • Star rating: ★★★★

Related articles on equity investing from Morningstar:

Get more Morningstar insights in your inbox

Terms used in this article

Star Rating: Our one- to five-star ratings are guideposts to a broad audience and individuals must consider their own specific investment goals, risk tolerance, and several other factors. A five-star rating means our analysts think the current market price likely represents an excessively pessimistic outlook and that beyond fair risk-adjusted returns are likely over a long timeframe. A one-star rating means our analysts think the market is pricing in an excessively optimistic outlook, limiting upside potential and leaving the investor exposed to capital loss.

Fair Value: Morningstar’s Fair Value estimate results from a detailed projection of a company's future cash flows, resulting from our analysts' independent primary research. Price To Fair Value measures the current market price against estimated Fair Value. If a company’s stock trades at $100 and our analysts believe it is worth $200, the price to fair value ratio would be 0.5. A Price to Fair Value over 1 suggests the share is overvalued.

Moat Rating: An economic moat is a structural feature that allows a firm to sustain excess profits over a long period. Companies with a narrow moat are those we believe are more likely than not to sustain excess returns for at least a decade. For wide-moat companies, we have high confidence that excess returns will persist for 10 years and are likely to persist at least 20 years. To learn more about how to identify companies with an economic moat, read this article by Mark LaMonica.

Uncertainty Rating: Morningstar’s Uncertainty Rating is designed to capture the range of potential outcomes for a company. An investor can think of this as the underlying risk of the business. For higher risk businesses with wider ranges of potential outcomes an investor should consider a larger margin of safety or difference between the estimate of what a share is worth and how much an investor pays. This rating is used to assign the margin of safety required before investing, which in turn explicitly drives our stock star rating system. The Uncertainty Rating is aimed at identifying the confidence we should have in assigning a fair value estimate for a stock. Read more about business risk and margin of safety here.