Which blue-chip industrial is following’s path to success?

The market was confused about Brambles Limited’s (ASX: BXB) surge in half year profits with the stock sinking deep into the red before staging a bounce to finish higher on Monday.

The stock tanked over 3% to a low of $9.33 but staged a late comeback to end 1.1% higher at $9.74 after the global logistics group posted a 205% uplift in earnings per share (EPS) to US28.1 cents on a 9% increase in revenue to US$2.75 billion for the six months to end December 2017.

However, underlying EPS growth, which strips out one-off items, only rose a modest US20.3 cents with management commenting about rising costs as US economic growth accelerates.

The pick-up in growth in the world’s largest economy should be nothing but sweet music to the ears of shareholders but they weren’t expecting a sting in the tail. The sting is from rising wage costs (thanks to the buoyant economy) and high lumber prices as Brambles makes wooden shipping pallets.

It doesn’t help that management didn’t increase its interim dividend either. It is paying a 14.5 cent per share distribution, the same as last year, when most other companies are increasing their dividends even as they fronted investors with a weak earnings report card.

Just look at Domino’s Pizza Enterprises Ltd. (ASX: DMP) if you need an example.

There is nothing much Brambles can do about commodity prices (except perhaps to move more quickly into plastic pallets) but it’s a little disheartening to hear that management doesn’t have any quick fixes for escalating labour costs.

It’s new Chief Executive, Graham Chipchase, who has been at the helm for the past year, is trying to combat rising costs with the use of technology that is similar to what uses for its own online logistics and distribution network.

This includes radio frequency chips (called RFID) to track shipments and artificial intelligence to reduce the number of workers it requires to run its business.

Mr Chipchase is also trying to get its disparate operational staff to work closer as a team where best practices in Europe can be transferred to its US business. Europe uses a higher level of automation as the region’s labour costs have always been a bigger issue than in the US.

But don’t expect any quick turnarounds. Efficiency gains from automation are hard to quantify at this stage and will likely take a while to flow through to its bottom line.

There may also have been concerns about the outlook for the logistics sector as pushes to own and operate its own shipping infrastructure. Companies like FedEx Corporation have been on the nose recently due to these concerns, and Brambles may also be afflicted by the negative sentiment.

Under the weight of these concerns, it is easy to see how Brambles, which is trading on a FY19 consensus price-earnings (P/E) of nearly 23 times, could succumb to profit taking.

However, these concerns do not change my medium-term upbeat view on Brambles as the company still represents one of the better ways to gain upside exposure to accelerating economic growth in the US and Europe.

Rising costs should be more than offset by increasing volumes, although I do acknowledge that double-digit underlying earnings growth may be a little out of management’s reach for FY18 and FY19.

Also, Brambles tends to operate more as a regional logistics company where most of its customers use its service to distribute goods around where they are located.

This means Brambles is more unlikely to be impacted by Amazon than FedEx, which counts Amazon as a customer.

Building materials company Boral Limited (ASX: BLD) is another good way to gain exposure to the US and the stock also suffered a sell-off when it posted its results last week before bouncing back.

I believe both stocks have room to climb further in 2018.

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Motley Fool contributor Brendon Lau owns shares of Boral Limited, Brambles Limited, and Domino's Pizza Enterprises Limited. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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