Isn't CHEP a business where the accounting inherently flatters the true economics of the business?
Pallets are assumed to have a useful life of 10 years. Their provision for lost pooling equipment ('IPEP' expense) was $185.5m in FY'24 (~3% of plant & equipment). Based on your post, it sounds like they can't accurately track this 'lost pallet' figure, so both the useful life and the loss rates of the pallets could be materially worse than assumed. At any rate, total capex in the continuing operations was $1 billion in FY'24, notably higher than depreciation. This seems to have been the case stretching back many years, even adjusting for the spike in timber prices (capex-to-sales for FY'24 was at its lowest level in 5 years).
On a cash basis, the returns on capital/equity are lower than you cite and, conversely, the valuation multiples are higher. Perhaps CHEP/Brambles is only a 'good' business if judged by the accountants, but may not even be 'okay' as judged by the cash register?
Maybe a stock like this is subtly a big AI winner, too.
AI gets to figure out how to optimize everything better than a human ever could. AI gets to leverage a real world, physical business that's a natural oligopoly. That seems like a theme to be trying generally over the next 5 years.
This line “ The lesson was learned: if you have a CHEP contract you are not going to run out of pallets ” reminds me of Lloyds of London and the San Francisco earthquake of 1906 (from Wikipedia):
“ one of Lloyd's leading underwriters, Cuthbert Heath, famously instructed his San Francisco agent to "pay all of our policy-holders in full, irrespective of the terms of their policies". “
Thanks for the newsletter! You've persuaded me that A) CHEPs is a good business and B) it has had lousy management in the past. I also like your suggestion to rename the company (if they do, that's a great sign, but if they don't, that's not good)
But this looks to me much more like a private equity opportunity than a passive investment. To me, a passive investment requires you to trust management. You've persuaded me that CHEPs' management could have and should have learned to just stick with their knitting (ie, just the blue pallets), but I didn't see management saying that they have learned their lesson. I'd want to understand why they kept making the poor expansion decisions year after year before I thought about investing. I'm not convinced that this problem is limited to upper management. I worry that some of the executives are working for their big break and are unsatisfied running a pallet pool.
I also didn't see much in the way of new ideas from CHEPs
To my mind, CHEPs is an asset to be squeezed. If you want to get the most profit out, cut costs, and likely replace people, that's private equity.
Analysis of business model, economics and managment seems coherent and likely accurate. The CHEP business is probably better than average or good. But its not cheap. Not a bit. Its "heads the future is really bright and I win, tails is anything less than really bright and I loose." The business earns at best a normalised $1 a share of cash and probably less. Even if the next few years build on this base, and this is projected to the horizon to grow above inflation at say 4-5% p.a. - not exactly a concervative assumption - then its still fair value to fully priced.
Thanks for the insightful post, John.
Isn't CHEP a business where the accounting inherently flatters the true economics of the business?
Pallets are assumed to have a useful life of 10 years. Their provision for lost pooling equipment ('IPEP' expense) was $185.5m in FY'24 (~3% of plant & equipment). Based on your post, it sounds like they can't accurately track this 'lost pallet' figure, so both the useful life and the loss rates of the pallets could be materially worse than assumed. At any rate, total capex in the continuing operations was $1 billion in FY'24, notably higher than depreciation. This seems to have been the case stretching back many years, even adjusting for the spike in timber prices (capex-to-sales for FY'24 was at its lowest level in 5 years).
On a cash basis, the returns on capital/equity are lower than you cite and, conversely, the valuation multiples are higher. Perhaps CHEP/Brambles is only a 'good' business if judged by the accountants, but may not even be 'okay' as judged by the cash register?
XXX = 1875.
I have nothing to add about the business, but really want to commend the thorough nature of the write-up. Well done.
Maybe a stock like this is subtly a big AI winner, too.
AI gets to figure out how to optimize everything better than a human ever could. AI gets to leverage a real world, physical business that's a natural oligopoly. That seems like a theme to be trying generally over the next 5 years.
This sounds like a logistical nightmare to:
- Figure out bad vs good customers & prune
- Manage relationships if customers change their operations to favour or disfavour pallet handling & therefore CHEP
- Figure out via tracking the movement trends (to improve operations & business development stratery) of pallets which:
i) has a capital cost to install tracking chips on each pallet
ii) has an investment cost into developing in house expertise, software systems, AI (a skill dive) to understand the movements
Personally I hate companies relying on operational excellence
This line “ The lesson was learned: if you have a CHEP contract you are not going to run out of pallets ” reminds me of Lloyds of London and the San Francisco earthquake of 1906 (from Wikipedia):
“ one of Lloyd's leading underwriters, Cuthbert Heath, famously instructed his San Francisco agent to "pay all of our policy-holders in full, irrespective of the terms of their policies". “
Hi John,
Thanks for the newsletter! You've persuaded me that A) CHEPs is a good business and B) it has had lousy management in the past. I also like your suggestion to rename the company (if they do, that's a great sign, but if they don't, that's not good)
But this looks to me much more like a private equity opportunity than a passive investment. To me, a passive investment requires you to trust management. You've persuaded me that CHEPs' management could have and should have learned to just stick with their knitting (ie, just the blue pallets), but I didn't see management saying that they have learned their lesson. I'd want to understand why they kept making the poor expansion decisions year after year before I thought about investing. I'm not convinced that this problem is limited to upper management. I worry that some of the executives are working for their big break and are unsatisfied running a pallet pool.
I also didn't see much in the way of new ideas from CHEPs
To my mind, CHEPs is an asset to be squeezed. If you want to get the most profit out, cut costs, and likely replace people, that's private equity.
David
Wonder if you’ve ever looked into Ardagh Metal Packaging? Similar business in some ways.
Ugh. One of the worst dogs in my portfolio :( $AMBP
Analysis of business model, economics and managment seems coherent and likely accurate. The CHEP business is probably better than average or good. But its not cheap. Not a bit. Its "heads the future is really bright and I win, tails is anything less than really bright and I loose." The business earns at best a normalised $1 a share of cash and probably less. Even if the next few years build on this base, and this is projected to the horizon to grow above inflation at say 4-5% p.a. - not exactly a concervative assumption - then its still fair value to fully priced.