Surging lumber prices were no match for Brambles: Reporting season roundup

-- | 07/09/2021

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Emma Rapaport: Hello, and welcome to Morningstar. I'm Emma Rapaport. Today joining us is Grant Slade. He's an equity analyst covering building and construction materials.

Grant thanks very much for joining us today. 

Grant Slade: Thanks for having me Emma.

Rapaport: Grant, it's been an interesting month for your sector. Can you give us some quick highlights and lowlights from building and construction?

Slade: Yeah, absolutely. I guess if we're to look more broadly across fiscal 2021, for building construction materials stocks. It really was a tale of two halves so following a weak first half showing resurgent building approvals in particular for detached houses and alteration and addition work, from the September quarter onward, it really led an improved second half performance in fiscal 2021. And within I guess, building and construction materials names some of the standout performances were from James Hardie, once again which continued to grow strongly above market in early fiscal 2022. As it really continues to garner that incremental share of the U.S. exterior wall siding market. Reliance Worldwide was a further standout performance which delivered in spates with the group EBITDA rising nearly 40% year-on-year as the pandemic drove heightened bathroom DIY repair and remodelling activity.

So while cyclical improvement was the theme of late fiscal 2021, we did see some weaker than expected results from some building materials names, including GWA Group and Brickworks, which has pre reported its full year fiscal 2021 results ahead of its results next month. But we think that's more of a reflection of just an exacerbation of some of the typical lag times that we typically see between housing starts and sales for particular building materials rather than more than anything else. And as we look into fiscal 2022, the pipeline certainly remains solid, for all building construction materials names. We've seen historical highs in building approvals in Australia for both detached houses and alteration and addition work in early 2021. And that will really fill that pipeline and support cyclical earnings growth for the sector in fiscal 2022.

Rapaport: Across the outlook statements from the companies under your coverage, did any of them indicate that they would all be affected by the New South Wales lockdowns or national lockdowns - the stoppages to construction?

Slade: Yes, certainly look number of names really across both building materials, including the likes of construction materials names like Boral and Adbri certainly have called out the short stoppage that was put in place in early fiscal 2022 by the New South Wales Government. And that ongoing delays on construction sites might see earnings off to a slow start in fiscal 2022. However, with the eventual reopening and relaxation of the social distancing, and restrictions we currently have in place, we think that fiscal 2022 will end on a strong note given the macro backdrop that we've seen with historically high building approval numbers earlier this year.

Rapaport: I'd like to focus quickly on on one of the stocks under your coverage that garners a lot of investor interest, which is Brambles. Can you give us just a high-level overview of the result? Some highlights and lowlights and what management's outlook for the next half?

Slade: Yeah, absolutely. So look, really there was a strong fiscal 2021 result for Brambles with the pandemic effectively driving heightened at home consumption of fast-moving consumer goods and fresh produce as households and consumers stayed home amid the pandemic. And that in turn, obviously drove strong demand for Brambles pallet pools, which support the supply chain of those FMCG and fresh produce supply chains. So as a result, we saw operating income grow at a very strong 8% year-on-year in fiscal 2021. As we look forward though, and we look into – now into fiscal 2022 for the business. Those climbing vaccination rates that we're seeing in North America, Europe and Australasia, which are Brambles three most important geographies, they will pose now a headwind to growth as we look into fiscal 2022. So we're expecting that earnings will tread water looking into this fiscal year. But nonetheless, Brambles palette pools do remain primed to continue to displace single use white wood pallets in particular in Brambles two largest markets of North America and Europe over the coming decade, and that's going to continue to drive strong growth for the business through the medium to long term.

Rapaport: Yeah, it's interesting because a lot of companies that we look at really struggled during the lockdown. But, you know, in your report you've talked about how vaccines and the removal of social distancing will actually be a bit of a headwind for this company. But still, you do see it as one of your best equity ideas. Can you walk us through why you think the stock is undervalued?

Slade: Yeah, absolutely. So, what it really is about is that piece that I just mentioned about, there's still a long runway of secular growth that remains in front of Brambles in both of North America and in Europe through the medium term. So in both of these markets, white wood pallets, which is single use supply chain pallets remain the norm, as opposed to the rule. And with Brambles offering a more cost effective, more environmentally friendly option in the form of its pooled pallet solution. We expect that Brambles will continue to chip away at the market share of those white wood single use pallets over the coming years. So, brambles as the global leader in supply chain pooling solutions, really has the opportunity to eventually grow in emerging markets, including China, India and Russia, when the time is right. Now, we don't see that, that's very much a long dated opportunity for Brambles, but it's an opportunity that nonetheless has value for Brambles shareholders. So it's really the confluence of those two factors, that when you bring those two together, Brambles looks compelling at the current share price relative to those long-term opportunities.

Rapaport: Right. Just moving quickly on to I guess, one of the more consumer focused brands under your coverage which is Pact. They make consumer plastic ware, bottles and things like that. They've really struggled over the last couple of years, but in your report, you say that you've really seen a turnaround in its result. Can you walk us quickly through how they've turned the business around and what your outlook is?

Slade: Yeah, absolutely. So look, up until early 2021 shares in Pact Group had screened as significantly undervalued. For an extended period of time, even sort of heading into the pandemic in early 2020. The stock certainly look cheap, with the business in the midst of a turnaround under CEO Sanjay Dayal that had been brought in to effectively to turn around the business. It's really the core consumer rigid packaging plastic business that has really struggled over the last sort of 2 to 2.5 years for Pact. Really, prior management had really kind of lost focus on that core of what Pact does and as a result, see a number of key customers leave the business. And the prior management also really sort of underinvested in the manufacturing network of the Australasian core business. So we've seen, a couple of tough years for the business.

However, we've finally seen the fruits of the turnaround begin to bear fruit, in particular in late fiscal 2021. So finally Pact has returned to earnings growth in fiscal 2021. Now, a lot of that really has to do with the good work that's been done on the turnaround of the business over the last 18 months. But it's also been inevitably supported by heightened demand for consumer packaging. So, it's the new operating model, reinvestment in the manufacturing network, as I said, those two kind of key pillars of the turnaround strategy, that in combination with, you know, a cyclical turn in the demand for packaging amid the pandemic saw really strong 15% year-on-year growth, for that core plastic packaging segment of Pact.

Rapaport: Okay, just to finish up, reporting season is an intense time for analysts. You have to read hundreds of reports and listen through hundreds of hours of earnings calls. Something that I really don't get to do. I'm just curious, was there an insight that you picked up from one of the calls, was there a particular theme that you picked up across management teams that you can share with us?

Slade: Yeah, absolutely look, inflationary pressures, which are mounting on seemingly unrelated businesses, as we head into this global recovery in 2021. So case in point would be, for example, building materials, James Hardie, is facing inflationary pressures that come from its raw material inputs. And similarly pallet pool provider Brambles is also facing significant inflation costs also in its operating costs, which are associated with a common element being lumber prices, which have spiked in North America. So what we're seeing is a confluence of a number of different factors coming together. Where resurgent housing starts in the U.S. have teamed up with increased demand for paper packaging, which in turn increases demand for wood pulp.

And then increased demand for supply chain pallets, as we've mentioned earlier, with households consuming more at home have all worked together to push lumber prices dramatically higher and impact, you know, two businesses that on the surface are seemingly unrelated, and yet they're facing similar inflationary pressures. You know, it's one of these examples, I guess that really underscores why we have a preference for businesses like James Hardie or Brambles that do have economic moats with both of these businesses, dealing with that inflationary pressure by being able to easily pass on those costs in price increases to their customers in fiscal 2022.

Rapaport: Yeah, I think a lot of investors would have taken note of especially the price of timber, really shooting up over the last couple of months just amazing to see. Grant, thank you so much for joining us today and sharing your insight.

Slade: Thanks Emma.

This report appeared on 2021 Morningstar Australasia Pty Limited

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