2006-12-18 Macquarie: BXB - Top Pick in the Sector

Brambles (BXB) shares have exhibited significant volatility, and have underperformed the broader market, since the company's DLC shares were reincorporated onto the Australian market on the 27th November. Despite this, Macquarie Research Equities (MRE) view this as a buying opportunity, suggesting that the share price will be supported by the on-market share buyback currently being undertaken with potentially over US$1.2bn of shares to be bought. In addition, the trading environment remains positive and margin expansion continues. Brambles has significant operating leverage and thus is a substantial beneficiary from new contract wins. According to MRE,overall, earnings certainty is high. MRE maintain that BXB is their top pick in the transport sector.

Brambles is trading on an FY08 EV/EBITDA multiple of 9.9x. This represents only a modest premium to the ASX100 all industrials index (ex financials, Resources, MAP and MIG) of 8.9x given Brambles superior industry positioning and global scale. At MRE's stretch valuation of ~US$15.50ps, Brambles provides over 20% of upside. The share price will be supported by the on-market share buyback currently being undertaken with potentially over US$1.2bn of shares to be bought (Brambles had originally announced a capital return of up to US$2.2bn of which US$926m was subscribed, leaving ~US$1.3bn. Thus far, Brambles has only purchased ~US$72m of stock at an average price of A$12.81ps onmarket). Even following the current round of capital initiatives, Brambles' balance sheet remains heavily under-geared and MRE see scope for a further US$2bn return to shareholders. Also free cashflow (post dividend payout ratio of ~55%) in the longer term remains very strong (~US$400m pa). Given this situation MRE also see the threat of takeover as plausible (in which case over $15ps would be expected). The trading environment remains positive and margin expansion continues. Brambles has significant operating leverage and thus is a substantial beneficiary from new contract wins. Overall, earnings certainty is high. By contrast, while MRE remain highly attracted to Toll's strategic positioning and growth prospects and have a high level of confidence in management, the share price is currently trading around MRE's base case valuation of ~$18.70ps. While MRE can stretch their valuation to ~$20-21ps incorporating takeover multiples, it provides relatively limited upside to the current share price. Furthermore there is near-term risk of the proposed separation associated with gaining ACCC approval, and earnings certainty is only moderate due to volatility in Virgin Blue's earnings (despite improvement, fuel is volatile and yield difficult to predict) and the potential distortion from acquisition accounting/provisioning associated with Patrick and Semblog acquisitions. MRE maintain their outperform recommendation, stating that CHEP is an exceptional business that MRE believe is unparalleled in its global positioning and scale.