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Why I think Brambles Limited (ASX: BXB) share price is heading higher

Global logistics group Brambles Limited (ASX: BXB) is joining the “slim-down-to-bulk-up” club by announcing the demerger of its reusable plastic container (RPC) business as it unveiled a four-fold increase in net profit this morning.

The share price responded with a 6.4% surge to more than one-year high of $10.60 as the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) added 0.2%. Brambles is the fifth-best performer on the index this morning and isn’t that far behind the top two gainers Afterpay Touch Group Ltd (ASX: APT) and Idp Education Ltd (ASX: ASX: IEL) at over 7% each.

Brambles announced that it was demerging its IFCO RPC division into a new listed ASX entity as IFCO had little synergies to its core CHEP pallets business. Management believes this is a value creating transaction as the capital requirements for both businesses are different and the split will better optimise the growth potential of the RPC and pallets businesses.

Brambles may have also been motivated by the positive market response to other demergers like BHP Billiton Limited (ASX: BHP) and South32 Ltd (ASX: S32), Wesfarmers Ltd (ASX: WES) and Coles, National Australia Bank Ltd. (ASX: NAB) and CYBG PLC/IDR UNRESTR (ASX: CYB) and Amcor Limited (ASX: AMC) and Orora Ltd (ASX: ORA) are just a few examples.

The IFCO entity, which serves customers in the fresh food sector, would be a ASX 200 stock with a market cap of around $1 billion and annual revenue of US$1.1 billion, according to the Australian Financial Review.

Brambles may also consider a sale of the business but it is more likely to opt for a demerger instead.

The news has overshadowed Brambles’ FY18 results with its statutory earnings per share (EPS) surging 309% to US47 cents thanks to a favourable exchange rate, US corporate tax cuts and a large impairment on its FY17 profit.

On an adjusted basis though and excluding exchange rate gains, underlying EPS increased 3% to US41.2 cents as revenue improved 6% to US$5.6 billion. Both figures were slightly ahead of consensus forecast, which would be a relief as the market was worried that it wouldn’t be able to even meet expectations.

I think Brambles may even enjoy a consensus profit upgrade for FY19 given that analysts have only pencilled in a 2.4% increase in EPS for the current year.

Brambles has a chance to beat this because its margins may improve going forward. The company has been battered by rising costs and it has only been able to pass on two-thirds of this to customers due to the contract period, which is typically three years.

As these contracts are renewed, Brambles will be able to re-adjust prices to recover what’s lost to inflation.

Further, many of Brambles customers have reported good quarterly results and upbeat outlooks. This bodes well for its ability to lift prices over the coming periods.

I believe there’s more upside to Brambles share price even after the big rally. The recovery story for Brambles is only just beginning.

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Motley Fool contributor Brendon Lau owns shares of AFTERPAY T FPO, BHP Billiton Limited, Brambles Limited, CYBG Plc, National Australia Bank Limited, and South32 Ltd. The Motley Fool Australia owns shares of and has recommended Wesfarmers Limited. The Motley Fool Australia owns shares of AFTERPAY T FPO and National Australia Bank Limited. 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.