Brambles (ASX: BXB) downgraded fiscal 2026 constant-currency underlying profit growth to 3%-5%, from 8%-11% previously. The downgrade is due to a shortage of repairs, causing an undersupply of pallets in Central and Northeastern US. Shares fell 20%.

Why it matters: Brambles outsources some of its repair functions, but with the exit of two major subcontractors in April, it has been unable to supply enough pallets to meet demand. We expect the shortage to unwind during 2026.

  • Brambles has ordered 2 million new pallets to be delivered gradually over the coming months, is sourcing new subcontractors, and can bring more repairs in-house if necessary. About half of the repairs are done in-house currently.
  • In the short term, we expect higher costs from redirecting pallets, including transportation, handling, and storage, and lost revenue from losing new business sales, supplying lower volumes, and mix shift to lower margin sales.

The bottom line: We lower our fair value estimate by 8% to $23 per share for wide-moat Brambles. We cut fiscal 2026 and 2027 underlying EBIT by 6% and 5%, respectively, reflecting slower new business growth, volume constraints, and higher operational costs. More significant is ongoing capital expenditure.

  • We think the adoption of artificial intelligence has accelerated automation in supply chains. This requires precision in pallet quality, with machines rejecting nonuniform pallets. But we think pallets are likely to reach their end of life sooner, and we lift our pooling capital expenditure estimates.
  • We think the sell-down is overdone. If we assumed Brambles needed to absorb much more capital, with pooling capex about 20% cost of sales at midcycle, from 17% currently, return on invested capital in 2035 would be 15% from 16%-17% in recent years. Here, shares would be valued at $21, still well above today’s prices.

Bramble’s caught short in pallets as major subcontractors stop repairs

Brambles is focused on the supply of pallets for consumer staples, which accounts for about 85% of revenue. Its market is primarily fast-moving consumer goods, including packaged food, beverages, fresh food, and personal healthcare.

Already in 60 countries, Brambles’ expansion strategy is to increase market share in developing markets. This includes Eastern Europe, parts of Southeast Asia, Turkey, the Middle East, Sub-Saharan Africa, China, and India. Within its established regions of Australia, Western Europe, and North America, we expect the firm to continue to acquire new customers and volume growth as it benefits from scale.

Most of the firm’s capital costs are related to the replacement of lost or irreparable pallets. While the firm incurred lower capital costs during the pandemic as customers stockpiled and reused pallets, subsequent automated supply chains have turned the tide. We think increased adoption of artificial intelligence has led to more widespread use of automated supply chains. These require very high-quality pallets, meaning they are likely to need more frequent replacement. We forecast capital costs for new pallets averaging about 15% of sales over our 10-year forecast period, from an elevated average of 25% over three years historically to fiscal 2023.

Brambles invests in efficiency initiatives such as the deployment of automated repair infrastructure and digital improvements, enabling tracking to reduce pallet losses and improve transportation routes. Repairs and maintenance, and transportation each account for about one-fourth of group operating costs, and our midcycle EBIT forecast of 25% is predicated on efficiency improvements driving lower expenses.

In the largest regions of North America and Europe, most customer agreements permit the firm to pass through high inflationary price increases through surcharges or pricing increases tied to indexes. Over fiscal 2021 to 2023, group revenue growth averaging 10% was mainly due to pricing changes and surcharge revenue given high inflation. However, we expect mid-single-digit revenue growth over our 10-year forecast period to fiscal 2035 as inflation normalizes.

Bulls say

  • Brambles’ global scale makes it a key logistics partner for many of the largest global fast-moving consumer goods brands, supporting business expansion in new regions.
  • With about 85% of revenue derived from fast-moving consumer goods, food and beverage, or fresh food companies, revenue and earnings streams are relatively resilient.
  • Improved recovery and repair should extend pallet life, reduce costs, and improve utilization.

Bears say

  • Wooden pallets could lose market share if more expensive plastic pallets become more widely adopted, given advantages in durability, weight, safety, and improved tracking.
  • Wooden pallets are an old technology and may be less suited for modern logistics, including automated warehouses.
  • Wooden pallets are subject to meaningful and costly damage and losses.