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Why a profit margin squeeze may be good news for Brambles Limited (ASX:BXB) shares

Now here’s an investment concept you don’t hear every day! Investors are being urged to buy shares in global logistics company Brambles Limited (ASX: BXB) because of rising cost pressure.

That’s the view of Credit Suisse who believes that the underperforming share price of Brambles provides a good entry point for investors.

The share price of Brambles has tumbled 12.5% over the past year, versus a 5% gain by the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) as investors shun the stock for its poor operating leverage and disappointing margins even though the company is well placed to benefit from accelerating economic growth in the US and EU.

Increasing costs from the skyrocketing fuel price and higher labour and lumber costs (lumber is used to make its pallets) are among the key challenges that are depressing its share price.

But these cost pressures may be the very thing that trigger a turnaround in sentiment towards Brambles.

“We expect Brambles’ competitors (PECO, whitewood pallet suppliers/recyclers) to be hit far more severely by the cost pressure, due to their lower scale and far weaker margins compared to Brambles,” said Credit Suisse.

“This is likely to reduce competition in the US, and ultimately Brambles is likely to pass on cost increases to customers.”

However, investors may need to wait one to two years to see any results as weaker rivals won’t exit the industry overnight and Brambles’ margins will likely stay under pressure during the transition.

This doesn’t mean that investors should be waiting to buy the stock though with the broker calling Brambles a quality business facing cyclical headwinds.

The company has an enviable market position, a capable management team and a credible turnaround plan for its US pallets business, added Credit Suisse which has an “outperform” recommendation on the stock with a price target of $10.25 a share.

The waning Australian dollar against the greenback is also good news for Brambles when it converts its US-dollar profits into the Aussie, although its cost increases are priced in US dollars.

Brambles isn’t the only quality ASX company that is leveraged to the US market. Plumbing solutions group Reliance Worldwide Corporation Ltd (ASX: RWC) is heavily exposed to the US market and it has just announced a $1.2 billion acquisition that will give it a beachhead into the UK and EU markets.

Other stocks with material exposure to the US and its currency are packaging company Amcor Limited (ASX: AMC) and building materials suppliers James Hardie Industries plc (ASX: JHX) and Boral Limited (ASX: BLD).

But Brambles isn’t the only stock that is well placed to outperform in 2018. The experts at the Motley Fool have picked their top three blue-chip stock ideas for the year.

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Motley Fool contributor Brendon Lau owns shares of Boral Limited and Brambles 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 Scott Phillips.

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