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Edited Transcript of BXB.AX earnings conference call or presentation 21-Aug-19 12:30am GMT

Full Year 2019 Brambles Ltd Earnings Call

Sydney Aug 27, 2019 (Thomson StreetEvents) -- Edited Transcript of Brambles Ltd earnings conference call or presentation Wednesday, August 21, 2019 at 12:30:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Graham Andrew Chipchase

Brambles Limited - CEO, Chairman of Executive Leadership Team & Executive Director

* Nessa I. O'Sullivan

Brambles Limited - CFO & Executive Director

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Conference Call Participants

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* Cameron McDonald

Evans & Partners Pty. Ltd., Research Division - Head of Research

* Jakob Cakarnis

Citigroup Inc, Research Division - Associate

* KyVan Tang

Colonial First State Asset Management (Australia) Limited - Co-Lead of Credit Research

* Matthew H. Ryan

UBS Investment Bank, Research Division - Executive Director and Research Analyst

* Niraj-Samip Shah

Morgan Stanley, Research Division - Equity Analyst

* Owen Birrell

Goldman Sachs Group Inc., Research Division - Metals and Mining Company Analyst

* Paul Butler

Crédit Suisse AG, Research Division - Director

* Scott Ryall

Rimor Equity Research Pty Ltd - Principal

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Presentation

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Graham Andrew Chipchase, Brambles Limited - CEO, Chairman of Executive Leadership Team & Executive Director [1]

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Welcome to our Fiscal '19 Results Presentation. As usual, I will do a brief overview. We'll hand over to Nessa, and then I'll come back again and do a bit more about strategy.

So if you look at the '19 results, sales revenue growth of 7%. And I think that's reflecting both our performance on pricing, but also very strong volume momentum across all our regions. The underlying profit up 2%. Again, strong revenue driving that, but also offset by group-wide cost inflation pressures as well as continued challenge in the Americas. So a few things there. One is the change in customer retailer behavior, which we've talked about before as well as U.S. network capacity constraints, which we've talked about before and the stringer to block conversion in Canada, and higher cost to serve in Latin America, and Nessa is going to talk about that in a bit more detail later on.

Our self-help strategy in the U.S. has been working, and you can see we're making good progress on the automation, on lumber procurement, productivity and pricing initiatives. And they're all on track to deliver progressive margin improvement through to the end of fiscal '22.

We had a very good year on free cash flow in fiscal '18 in terms of providing enough cash to pay the dividend and the investment. But in '19, you can see we were down -- just under $90 million, and that's largely due to the $73 million we invested in the U.S. automation program which clearly was funded by the divestment of businesses like HFG in prior years, but also only having 11 months of IFCO cash flow. ROCI of 19.5% remains very strong and well above the cost of capital.

So just moving on to IFCO. So we sold IFCO in June, and that completes the program we have of selling the major assets and leaves us in a sort of a very streamlined and focused place going forwards. The sale of IFCO provides us with just under $2.5 billion net proceeds. It leaves us in a very unique I think opportunity to reshape where we're going in terms of direction, making us, I think, fit for the future and in a strong position going into the 2020s and beyond and I'll talk about that a little bit more later on.

If you just look at what we're doing with the cash proceeds, so as I said, a $2.4 million -- $2.4 billion net proceeds. So as we explained previously just under $2 billion we're going to return back to shareholders in 2 ways. So the first is the on-market share buyback of $1.65 billion, which we started in early June '19, and we purchased 6 million shares so far at a cost of AUD 77 million and we expect based on sort of normal run rates of what we'd be buying that program to be finished in about early fiscal '21.

The second element of the share proceeds going back to shareholders is around a capital return, a special dividend. So there's a capital return of AUD 0.12, which is subject to our shareholder approval in the 2019 AGM, together with a special dividend of AUD 0.17 per share. Then the balance, which is about $4 billion is going to be used to pay down debt. And again we talked about that previously, and I think all of these things leave us in a position where we're very much focused on maintaining a strong balance sheet and investment grade credit profile.

So again one of the other things we talked about when we announced the divestment of IFCO was that we would as a board reassess our dividend policy. So as a result of that review, we've decided that from starting with the fiscal '20 interim dividend we'll be moving to a payout ratio policy. So the main reason for doing that clearly is to align shareholder payments with movements in earnings, but also to support future growth opportunities all the time maintaining the strong investment grade profile.

The way we'll do that then is target a payout ratio of between 45% and 60% of underlying profit after finance costs and tax, and of course subject to our cash balances. The dividend will be paid -- sorry, will be declared in U.S. cents and then paid in Australian cents. And because of the ongoing share buyback program, we're going to continue to suspend the dividend reinvestment plan. As I say, the whole point about this is we continue to be committed to strong balance sheet and investment grade credit profile.

Just moving on a bit to the operating landscape and the outlook for fiscal '20. So it's not all bad news in terms of the operating environment. And if you look at the first couple of points there, those are positives in terms of -- we still have large addressable opportunities both in developed and emerging markets. And competition, whilst it's robust, is still very rational. And again I think that's an important point to remember when we're looking at competitor activity.

Now we are seeing a slowdown in major economies. And yes, I might be British and therefore Brexit might be top of mind, but it's not just about Brexit in Europe. And I've been saying this for some time to you that we thought there was a slowdown coming in GDP, particularly in Germany, France, and we're now seeing that. And I think Italy would have seen it ahead of snap -- election is going to take place very soon. So I think across Europe, we're seeing a slowdown. It's not just related to Brexit.

And on top of that, whilst nothing happened yet, I think it's near the contagion that could come from a U.S.-China trade war is something we also have to bear in mind. And both of those things -- the European slowdown is definitely going to be something we have to face in fiscal '20. And it's possible that a wider contagion could also be fiscal '20.

On top of that, not something else which hasn't changed, but is still present is that the retail landscape is changing. And of course, that means that the business models of our customers are changing, it's putting more and more pressure on the supply chain and us as suppliers. We continue to see inflationary cost pressure. And although the rates of transport and lumber is moderating, in some markets more than others, we still expect to see inflation in our main markets, particularly Europe and the U.S.

And finally if we look at the financial outlook, so if we take into account what we've been talking about around inflationary pressures and the macroeconomic pressures and -- but also take into account AASB 16, which even though I am an accountant I'll be more than happy to let Nessa explain in a minute. Our view is that the revenue growth from fiscal '20 will be at the lower end of our single -- mid single-digit growth objective. And I think that is particularly valid when you think about Europe and the automotive sector. And again we've talked a bit about automotive, but if you read any paper you see more and more of the large automotive OEMs are cutting production and that has an impact because we have a reasonably sized automotive business, particularly in Europe.

So with that sort of revenue growth, we're anticipating underlying profit growth, including the impact of AASB 16, to be in line with the revenue growth or slightly above. And I do think that is -- would be a very creditable performance in the context of the larger macroeconomic position as we go into fiscal '20.

So with that, I'll hand over to Nessa to go through the numbers.

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Nessa I. O'Sullivan, Brambles Limited - CFO & Executive Director [2]

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Thanks, Graham, and good morning, everyone. So now to go into more detail for the results release. So before getting into the FY '19 results, I'd like to take a moment to outline how the new accounting standards introduced during the year and the sale of IFCO are presented in our financial statements. We'll also come back to the impact of AASB 16.

So starting with the accounting standard changes, the new revenue standard AASB 15 and financial instrument standard AASB 9, both came into effect on the 1st of July 2018. So the 2019 income statement and balance sheet have been prepared in accordance with AASB 15, and the 2019 balance sheet has also been prepared in accordance with AASB 9. It should be noted that neither accounting standard has any impact on cash flow.

And following the completion of the sale in May 2019, IFCO has been classified as discontinued operations in FY '19 with the prior year comparators in the income statement being restated. The FY '19 balance sheet reflects the sale of IFCO, however, the FY '18 comparative balance sheet has not been restated and that's in line with accounting standards. But to assist with your review of the year-on-year comparisons, we have added additional footnotes in the accounts this year.

From a cash flow perspective, IFCO cash flows were included in the group cash flow for 11 months up to the date of divestment at the end of May and that's in the 2019 cash flow. And the prior year, the cash flows for the group are unchanged and therefore include the full 12 months of the IFCO cash flow.

So turning to our FY '19 results on Slide 9. Group sales growth of 7% is ahead of our objective to deliver annual revenue growth in the mid-single digits. Underlying profit growth of 2% was driven by the strong sales performance and productivity gains, which more than offset ongoing input cost inflation and broader cost challenges across the group. Significant items for FY '19 include $945.7 million gain on the sale of IFCO, and that's reported in discontinued operations. Significant items expense in continuing operations of $62.8 million includes IFCO sale related items and expenses related to Latin America, and we'll cover that in more detail in the presentation.

Net finance expense decreased by just under $15 million during the year, and that was largely due to the debt refinancing that we did in FY '18 as well as having lower debt balances following the divestments in FY '18 of HFG and CHEP Recycled as well as the benefit for the last month of the year when we had the $2.4 billion proceeds from the IFCO sale banked.

The tax expense increased to $76.5 million, but the increase is largely due to us cycling the $65 million one-off credit that we reported last year relating to the change in the U.S. tax regulations. In FY '19, we had the introduction of U.S. BEAT tax, and that drove increased tax expense and contributed to the higher underlying full year effective tax rate of 29%. Profit after tax and statutory earnings per share both increased by a very impressive 112% due to the IFCO gain on sale of $945.7 million, which is recognized in discontinued operations.

Turning to Slide 10. Sales revenue growth was 7%, and pleasingly it reflected meaningful contributions from all the CHEP segments globally. And as you can see from the chart on the right-hand side of the slide, volume growth remained in line with the prior year despite increased price realization in FY '19.

Price mix growth increased to 3% in the year, up from 1% in FY '18, and that's reflecting pricing actions taken across the group in response to input cost inflation and higher cost to serve in certain regions. Volume growth was driven by net new business growth of 3% and 1% organic like-for-like growth. Our Pallets business continued to win new customers as well as expand into new lanes with existing customers. Volume growth was particularly strong in European pallets as well as in the European Automotive business, noting that the European Automotive sales contributed 1 point to the overall group revenue growth following a large contract win in FY '18.

So looking at the group underlying profit in more detail, the sales contribution of $177 million was strong, reflecting sales growth, net of volume related costs with the exception of depreciation and IPEP, which are not shown net of volume. Depreciation increased $34 million due to the growth of the pool to support strong volume growth across the group as well as increased investment in supply chain initiatives such as the U.S. automation program.

Transport costs, net of efficiencies and U.S. transport surcharges increased $44 million, and that was driven by third-party freight inflation in all markets as well as additional relocations in the U.S. related to service-center capacity constraints as well as changes in retailer and customer behavior, which meant that we had additional transport lanes.

Net plant costs increase of $44 million reflected additional repair and handling costs associated with both the U.S. pallet quality investment program as well as impacted by the automation projects. We also had costs associated with the stringer-to-block transition in Canada, which includes the impact of an inherently higher damage rate in relation to block pallets. IPEP expense increased $31 million during the year, $18 million of this increase related to volume growth, market mix changes and higher unit pallet costs, particularly in Europe. The balance of the increase of $13 million relates to Latin America and IMETA regions, where additional expenses were booked to reflect assessments of higher risk of asset recoverability in these regions.

Other costs increased $8 million as investment in additional resources were made to support commercial and asset management initiatives across the group, and was partly -- this was partly offset by a year-on-year benefit as we cycled an operating loss in the HFG joint venture from the prior year.

So let's look in more detail at cost inflation. So one of the key things that we highlighted last year when we talked about FY inflation was that largely the impacts of inflation were weighted to the second half of the year. The net inflation impacted on underlying profit in FY '18 was $19 million, and that was primarily driven by transport inflation with lumber inflation largely impacting CapEx and it increased the FY '18 pallet purchase costs by $21 million.

So in FY '19, we then had a full year impact of the higher inflation costs. However, offsetting the higher costs, we actually had higher recoveries from pricing and surcharges, which were being progressively put in place through FY '18 and '19. The net inflation impact on the FY '19 operating cost was $10 million, which is $9 million lower than the impact in FY '18.

In FY '19, transport cost inflation continued in all markets, however, the rate of inflation did slow down in the second half of the year. Lumber inflation also moderated during FY '19, and this is reflected in the full year impact on CapEx, which is reduced from $21 million in FY '18 to $8 million in FY '19, and this is set out in more detail on the capital expenditure slide which we'll get to later.

So in Europe, our primary mechanism when you think about inflation, our primary mechanism for recovery is the price indexation, and this is present in all the contracts that we have and covers labor, lumber and fuel. And when you think about it, the indexation is largely reset once a year and at the start of the year, from 1 July is traditionally our reset date.

In the U.S., however, how we recover inflation is different in that it's largely through transport and lumber surcharges, which are recognized as an offset against the related cost in the income statement. So -- and as we consider then having looked at what's happened in '18 and the exit rates in '19 and looking at the potential impact of inflation in FY '20, we expect transport inflation to continue in all markets, although we do expect the rate of inflation to be lower than in FY '19 in line with industry trends.

In terms of lumber inflation, which is predominantly a driver of CapEx, moderate inflation is expected to return to the U.S. following deflation in FY '19. In Europe, we expect lumber inflation to continue albeit at a lower rate than the current year. In addition to transport and lumber, we also expect wage inflation to increase given unskilled labor shortages in most markets. We also expect to see increased property inflation in line with higher demand for industrial warehouses, particularly from the e-commerce players.

Turning to our segment results and starting with CHEP Americas on Slide 13. Sales revenue of 7% was driven by solid volume growth, including U.S. volume growth of 2%, and ongoing expansion with new and existing customers in Latin America and Canada. Price growth improved in the period with the U.S. effective price being at 4% and that's including of the surcharges that offset against the costs and increased price realization was also delivered in both Latin America and Canada, reflecting price recovery of higher cost to serve in both businesses.

Segment margins declined by 2.2 points during the year with the U.S. accounting for 1 point of the decline and the balance driven by Canada and Latin America. Price realization and efficiency gains were insufficient to offset input cost inflation and broader cost challenges in all 3 pallet businesses. I'll outline this in more detail in the next few slides.

Overall ROCI declined by 2.2 points, driven by the lower earnings and increased capital investment to support volume growth and supply chain initiatives in the region. As we look to FY '20, we expect U.S. pallet margins to improve by approximately 1 point in line with our FY '22 margin expectation -- improvement expectations. We anticipate cost headwinds in Canada to continue, reflecting higher ongoing costs associated with running 2 pallet pools and recognizing the higher damage rate associated with block pallets.

We would expect to see progressive improvement, however, in Latin America over the next 3 years through improved pricing cost recovery, reduced flows into higher risk areas of supply chain and improved asset collections and asset management across the supply chain.

Breaking down CHEP Americas' underlying profit and margins further, the waterfall chart on the left-hand side outlines the key drivers of the underlying profit in the region, which largely reflect the inflationary pressures and broader cost challenges outlined in the previous slide and in the group profit bridge on Slide 11.

I would draw your attention to the margin performance chart on the right-hand side. This chart breaks down the phasing and contribution to margin decline from the 3 regional businesses, U.S., Canada and Latin America across the first half of the year, second half and the full year. Year-on-year, CHEP Americas margin -- the region margin decreased 2.4 points in FY '19 with a relative improvement and shift in business mix contribution to the margin decline in the second half of the year.

Taking each business in turn, starting with the U.S., which is represented by the dark blue in the chart. The U.S. business accounted for 1 point of the FY '19 Americas full year margin decline and only 0.4 points of the second half decline. The moderation in the second half reflected increased cost recovery through pricing initiatives, supply chain efficiency and more favorable comparatives as we cycled higher levels of lumber and transport inflation in the second half of '18.

Latin America and Canada, represented by the other bars in the chart, collectively accounted for 1.3 points of the FY '19 Americas margin decline and accounted for most of the margin deterioration in the second half of the year. In Canada, margins were impacted by the stringer-to-block transition, which reflects additional costs associated with managing 2 pools and higher damage rate on block pallets.

In Latin America, the margin deterioration in the second half reflects increased cost to recognize a higher risk of loss in the region and investment in overhead and other resources to improve commercial and asset management outcomes.

Looking then at Latin America in more detail and providing context for that and specifically at the cost pressures in the region and the mitigating actions we're taking to improve asset management, pricing and improved commercial terms to reduce cost, increase cost recoveries and drive behavioral changes across the supply chain to improve asset accountability. So if we start with the context of the historical operating model. Cycle times in Latin America have historically been high for 2 key factors. Firstly, the wide geography and lack of network density both contributed to longer cycle times in the region. Also the ability to control retailer and customer behavior in developing markets tends to be challenging with longer cycle times before scale efficiencies occur.

Given our experience in other regions, we would expect cycle times to reduce over time as the business grows and network density increases. Despite strong growth, however, and increased density in Latin America over the last number of years, we weren't seeing a commensurate reduction in cycle times. In light of the extended cycle times, we changed our accounting methodology to recognize increased costs to serve in FY '18 with a higher IPEP charge in underlying earnings and significant item expense relating to asset flows in prior periods.

Recognizing the need to address both cost and cost recovery in the market, a new management team was put in place. The new President and CFO have extensive commercial supply chain and asset management experience. And in the first half of FY '19, a detailed 3-year business improvement plan for the region was developed, which we started implementing in the second half of FY '19. The plan itself focuses on transforming asset control processes to reduce capital intensity in the market, increasing the level of asset recollections direct from stores and from higher risk channels, market mapping to identify new collection points to enable us to establish commercial relationships and to also include those in our collection network. We are also focused on implementing pricing to recover cost to serve and to improve asset accountability across the supply chain and active management of flows to reduce the flows going into the higher risk areas of the supply chain.

So we've invested in overheads to enable the asset recovery controls and improved commercial terms to be implemented. And since activating the plan in the second half of 2019 financial year, we've gained improved insights into the market, specifically around asset collection risks. These insights have informed an updated assessment of the risk to recoverability of assets in certain parts of the market and have resulted in an $11 million increase in FY '19 IPEP expense in underlying earnings relating to the current year flows and a $21 million significant item expense relating to historic flows.

Importantly, we've taken actions to actively reduce higher risk flows and increase pricing to reflect the higher cost to serve. Despite the implementation only beginning in the second half of the year and therefore having a short time to have an impact, the business improvement plan is already delivering strong results. We're seeing enhanced asset controls and a strengthened commercial capability being evident within the team, but also in terms of the commercial actions being taken. Higher pricing has been implemented in the fourth quarter at a level of increase well above inflation and supporting cost recovery. We've also seen record levels of asset recollections in the market in the FY '19 year. And importantly, we've already seen a material improvement in the FY '19 CapEx to sales ratio, which is evidencing lower capital intensity in the business. And we've also identified other opportunities to further improve the business model. These early wins are giving us confidence in our plan and the ability to deliver progressive improvements over the next 3 years, which are embedded in the plan.

Turning now to the U.S. Pallets business. Looking at U.S. sales revenue in more detail, you'll note the quality of the sales growth with a well-balanced volume and pricing growth being realized. Price realization improved 3% in FY '19, up from 1% in the prior year, and that's reflecting the pricing actions we've taken to offset inflation and higher cost to serve in the business. Volume growth was solid at 2%, which was particularly pleasing in light of the improved price realization.

Turning to Slide 17 and our U.S. pallet margin improvement initiatives. You'll be familiar with this slide, which we've shown before, which outlines the key initiatives we're implementing to improve margins over the next 3 years. We have made good progress in FY '19 in relation to both pricing and the automation and lumber projects, which remain on track to deliver the expected margin improvements to FY '22.

Our annual network and transport optimizations delivered incremental supply chain efficiencies in FY '19, and we expect ongoing savings from this initiative over the next 3 years. After 18 months of inflation, we're now well progressed through renegotiating our portfolio of contracts to better capture the cost to serve through contract repricing and surcharge clauses, which helps to insulate our business from future inflationary pressures.

In FY '19, we delivered effective pricing of 4%, if you take the price realization on the top line and add the surcharging realized that's netted off against the cost line. As indicated by the progressive darker green circles in the table, we expect increasing benefits from pricing actions over the next 2 to 3 years as we further renegotiate our contract portfolio, bearing in mind that the average length of a contract is 3 years. The largest contributor to the outlook margin improvement is expected to be delivered from the return on investments, net of related depreciation, from our U.S. automation and lumber initiatives. Both remain on track. These programs are funded from the FY '18 asset actions, which were undertaken to reallocate underperforming capital invested in the business to be reinvested in high returning investments in the core business.

The FY '18 asset actions delivered $252 million in proceeds, $102 million came from the sale of the U.S. recycle business and $150 million came from the shareholder loan repayment as part of the exit of the HFG joint venture. These funds are now being progressively reinvested in high returning projects.

Summarizing the slide, collectively we're confident that these initiatives will deliver 2 to 3 points of margin uplift from the first half '18 levels of -- by FY '22. Given the phasing of benefits from each initiative, we expect margins to improve at a rate of about approximately 1 percentage point per year in FY '20, '21 and '22.

So looking -- given that the weighting of the improvement is towards the automation project, looking in more detail at that project, the overall project was a planned investment of around $160 million over 3 years to increase automation level in the U.S. from about 50% today to 85% by FY '22. The project will automate between 50 and 60 plants between FY '19 and FY '21 and is expected to have a 5-year payback, which is consistent with other automation projects undertaken in both Europe and previously in the U.S.

The funding from the projects as referenced earlier is coming from the asset actions which we completed in FY '18 from the sale of recycled and the exit of HFG. Since the launch of the project, we have now automated 20 sites, and we're pleased with the performance of the automated sites, which are broadly in line with the investment case. A further 17 sites have been identified for automation in FY '20, and we remain on track to deliver the plan and associated benefits over the next 3 years.

Turning to CHEP EMEA. CHEP EMEA once again delivered a strong result despite increasing revenue and cost headwinds, largely linked to macroeconomic uncertainty in the region. Revenue growth of 8% was driven by net new business wins in the European pallet and automotive businesses and inflation-related price increases in the region. It should be noted that the region benefit from 2 points of growth was from the automotive business.

The sales result was achieved despite a notable slowdown in like-for-like volumes, particularly in Europe. Underlying profit margins declined by 0.7 points as improved pricing and supply chain efficiencies were insufficient to offset direct cost increases, including transport inflation, Brexit-related pool inefficiency and increased repair and handling costs associated with Brexit. Additional IPEP charges were taken in the year, recognizing both a higher unit cost pallet cost in Europe and also higher incidence of loss in the IMETA region.

ROCI remained strong at over 24% despite inflationary pressures, Brexit-related costs and capital inefficiencies as well as increased investment to support volume and new market development. As we look to FY '20, we expect volume growth to be impacted by lower like-for-like volumes in Europe and a broader slowdown in the global automotive industry. Whilst we continue to prepare for Brexit, the exact impact of a hard Brexit outcome remains uncertain.

Looking at the EMEA sales growth in more detail, the chart on the slide outlines the composition of revenue growth over the last 3 years. In FY '19, price mix contribute 2% to growth, up 1% from FY '18 and following no contribution in FY '17. This increase reflects the increase in contractual pricing and indexation, driven by inflationary pressures in the market over the last 2 years.

Like-for-like volumes were flat in FY '19, reflecting the economic slowdown in Western Europe and the global automotive industry. Net new business growth remained strong at 6%, reflecting growth in pallets with new and existing customers across the region and a 2 percentage point contribution to EMEA growth from the automotive business following a large contract win in the prior year. As we look to FY '20, we expect like-for-like volume growth to continue to be impacted by broader economic uncertainty, particularly in the European pallets and automotive businesses. The rate of net new business growth is expected to be lower, particularly in automotive, while pricing growth is expected to be in line with the inflationary cost environment.

Turning now to CHEP Asia Pacific. The Asia Pacific region delivered another strong result in FY '19. Sales growth of 3% was driven by solid pricing and volume growth in the Australian Pallets business. Underlying profit margins and ROCE both improved, reflecting sales mix benefits, effective cost control and a number of one-off items, including a one-off infrastructure grant in Asia and favorable asset recovery in Australia.

In terms of outlook and how you should think about it for FY '20, we expect revenue and profit headwinds from the loss of large RPC contract in Australia, we also expect a reduction in margin and returns reflecting the cycling of benefits from one-off items in FY '19. And also we expect increased investments in FY '20 to support new business growth across the region.

Turning to significant items. In discontinued operations, we recognized the $946 million post-tax gain on the sale of IFCO, the proceeds from which were received on the 31st of May 2019. In continuing operations, we recognized $42 million of IFCO-related costs, which included $8 million of restructuring costs and $22 million of asset writeoffs. And we also reflects -- it also reflects $12 million related to the early repayment of the U.S. 144A April 2020 bond, which was repaid with IFCO sale proceeds in July 2019. The interest expense benefit and the cash outflow associated with this early repayment will be recognized in FY '20. The balance of the expense of $21 million reflects the provision taken in Latin America in light of the updated assessment of risk of assets being irrecoverable, which I outlined earlier in the presentation.

So moving now to Slide 23 and our cash flow performance. Cash flow from operations declined $293 million year-on-year, and that was largely due to the mismatch of the timing of receipt of funds from the underperforming assets in FY '18 and the related reinvestment into core business high-returning projects in FY '19.

So the FY '18 cash flow shown here includes the receipt of proceeds from the repayment of HFG shareholder loan of $150 million, and the FY '19 cash flow includes $73 million of reinvestment of these funds into the U.S. automation and lumber projects. The investment into these programs increased year-on-year by $56 million.

As highlighted in our FY '18 result, the FY '18 working capital benefits of $30 million reversed in FY '19, and that accounts for an additional $60 million of the year-on-year decline. The current year outflow also included $18 million of additional CapEx to fund Brexit related retailer stocking levels in the U.K., which drove higher cycle times and requirement for more pallets. Free cash flow after dividend also includes the impact of only 11 months of IFCO cash flow contribution compared to the prior year, which had a full 12 months. This was partly offset by lower cash dividends payments due to a weaker Australian dollar. FY '20 will reflect the payment of the FY '19 final dividend, which remains in line with the first half '19 interim dividend without any cash contribution from IFCO in FY '20.

So turning to Slide 24, and if you take out the noise from the cash flow, given that we had a mismatch of funds.

To understand our true normalized free cash flow performance, it's important to adjust for the timing differences of exiting the low-returning businesses in FY '18 and the progressive reinvestment of the capital into the high-returning U.S. accelerated automation and lumber projects.

In FY '18, we -- collectively, we received over $250 million in proceeds from the exit of the HFG joint venture and the sale of the U.S. recycle business. The repayment of the $150 million shareholder loan was included in cash flow from operations, while proceeds from the sale of the U.S. recycle business was not included in the cash flow from operations. As announced to the market at the 2018 Investor Day, these proceeds would be reinvested back into high-returning projects.

In FY '19, we invested $73 million of the proceeds received in FY '18 into these programs. The final normalization adjustment is the $30 million working capital timing benefit received in the second half of FY '18 that reversed in FY '19, and this was highlighted to the market at the FY '18 results presentation. Once you've made these adjustments, you'll see that on a normalized basis, we've met our positive free cash flow objective for the last 2 years.

Looking at capital expenditure in more detail and reading this in conjunction with Appendix 9, total CapEx investment in FY '19 was $1.1 billion, and that represents a constant currency increase of $91 million over prior year. The increase was driven by the increased investment in growth, including $30 million investment in the European automotive business, $18 million on Brexit-related pallet purchases and a further increase of $8 million driven by lumber inflation as well as $37 million increase in non-pooling CapEx to support supply chain initiatives. The increased investment required was partly offset by $34 million of pooling capital efficiencies.

In FY '20, we expect a reduction in pooling CapEx to sales, driven by asset efficiency, while investments in U.S. supply chain programs are expected to remain at current levels and broadly in line with the program presented to the market in 2018.

Graham spoke earlier about how we'll use the IFCO sale proceeds. And what I'd like to do here is give you an overview of how these have been recognized in our balance sheet and the implications for net debt and interest expense in FY '20. We received net process -- proceeds after transaction costs and net of cash of approximately $2.4 billion. We placed AUD 2.1 billion on deposit in Australia and bought back -- and we have already bought back USD 54 million of shares up to June 2019. You see Graham referenced the Australian dollar amount in the earlier slide. And we used a further $500 million for the earlier -- early repayment of the April 2020 U.S. 144A bond.

Collectively, the use of IFCO proceeds significantly reduced net debt in FY '19. As we look to '20, we expect net debt to increase following the $0.3 billion capital return in October 2019 and as a result of the continuing share buybacks over FY '20.

In terms of interest, the early repayment of the 144A bond will deliver interest savings in FY '20, and we will receive interest income on funds in deposit in Australia. Net interest expense is expected to progressively increase in line with net debt increasing as we progress through capital management over the next 12 to 18 months. We expect FY '20 interest to be somewhere between USD 90 million and USD 100 million. In line with the outcome of our capital management structure review, we expect our financial profile after capital management actions to remain in line with our financial policies, which support a conservative balance sheet and investment-grade credit ratings.

Turning to Slide 27. Our balance sheet remains strong as we enter FY '20 with additional financial flexibility following the IFCO sale. Net debt decreased to $98 million as of the 30th of June 2019, and our net debt to EBITDA decreased to 0.08x, reflecting the receipt and subsequent use of IFCO sale proceeds, as outlined in the previous slide.

Net debt levels and consequently, leverage levels will progressively increase over the next 12 to 18 months, as the IFCO proceeds are used to fund the capital management initiatives. The increase will be consistent with our renewed commitment to maintaining both a conservative balance sheet and our current investment-grade credit rating of BBB+ from Standard & Poor’s and Baa1 from Moody's.

So turning to AASB 16, there have been a couple of questions on this. So as we look to FY '20, we wanted to provide you with an overview of the expected financial implications of the new lease accounting standard, which comes into effect in FY '20. So from a balance sheet perspective, we expect a reduction in net assets of approximately $100 million as we recognize lease liabilities of between $740 million to $760 million and lease assets of between $640 million to $660 million on our balance sheet.

We expect a $25 million benefit to underlying profit as lease asset depreciation expenses of $115 million will replace current operating lease charges of $140 million. The impact on profit after tax will be a small shortfall as the underlying profit benefit will be offset by $30 million of additional interest expenses associated with lease liabilities recognized on the balance sheet.

We expect $110 million benefit on the reported cash flow as the removal of $140 million of operating lease payments is partly offset by $30 million of additional interest expense on lease liabilities. The remaining $110 million of lease payments will be treated as repayment of financing liabilities.

So finally, to finish on the FY '20 outlook, turning to Slide 29. This includes the impact of AASB 16. Taking into account the ongoing slowdown in global economies and automotive industry, constant currency sales revenue growth is expected to be at the lower end of our mid-single-digit growth objective; underlying profit is expected to be in line with or slightly above sales revenue growth; our effective tax rate is expected to be around 30%; while net interest expense is expected to be between $90 million to $100 million as interest savings of the early redemption of the 144A bond and lower net debt are expected to be offset by the impact of AASB 16 and other funding impacts.

I'll now hand back to Graham. Thank you.

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Graham Andrew Chipchase, Brambles Limited - CEO, Chairman of Executive Leadership Team & Executive Director [3]

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Thank you, Nessa. Well done. And what I'd like do now is just go through bit of a strategy update and talk a little bit about the progress we've made, but also what we're expecting to do going forwards.

I mean our strategy starts from a clear understanding of what we do and why we do it and why our people come to work every day, our purpose statement. And yes, I think we've -- anybody who has covered the company for a while knows that we play a critical role in the global supply chain, and we're determined to make the supply chain safer, more efficient and more sustainable.

Our circular share & reuse model is absolutely fundamental to what we do. Just one example. And we've been getting a lot of recognition for the model and how we are in terms of its sustainability. But one example of several bits of external recognition is Barrons have just voted us the second most sustainable international company in the world for 2019. It's a great testament not only to the strength of what we do in the model, but also the way we actually go about it and the company and its people.

This you've seen before. We set this out 2 years ago in terms of our strategic priorities. So there's nothing new there, but we've made significant progress against each of these priorities, and I'll talk about those in a minute. But I think the important thing is if we deliver on these strategic priorities, it will then deliver what's on the right-hand side of the slide, which is the financial objectives through the cycle. And again, we've talked about this before, nothing new there.

This is something that we shared at the Investor Day in terms of the first 3 steps of this stairway, if you like. And we've been doing it for the last couple of years. So if you look at the first 3 steps, first one is fixing the fundamentals, then investing for excellence and the third one is delivering results. And there's always more to do, but we've made strong progress on all of these areas. So simplifying the portfolio and our business structure, we've done a lot on, sharing best practices across the whole group, across the whole world in procurement, automation and lumber and adapting successfully to a high and variable inflationary environment. So we've done all that, and you can see in the deliver section in terms of pricing, increased network capacity and improving quality, and we've done a lot on that.

The last step is what we'd like to talk in more detail in May at Investor Day, but it's really around shaping our future as we become a more focused business where we think we can do more around making the customer experience more frictionless and less painful, transforming our value proposition and simplifying the way we actually operate as a company. So I'll talk a little bit about that now, but there'll be more to come in May.

Before I do that, let's just go back to the external market dynamics. Yes, we've talked a lot around the changing face of retail and fast-moving consumer goods. So I'm not going to do more of that. We've also talked about the macroeconomic uncertainty, I will reiterate that just to make sure everyone is very clear around our views of it. In Europe, we are facing, I think, significant uncertainty, it's not just Brexit. And I think it's harder to call about what the impact of a U.S.-China trade war might be, but it certainly is something out there that we've got to take into account.

I think the third one, though, is important to talk about. I mentioned it a bit from an internal perspective about sustainability, but there's an increasing importance of sustainability and the social license to operate for all companies. We're getting -- and we're all seeing consumer pressure for more sustainable products and a more sustainable supply chain, and from a regulatory and investor perspective, there's need for more transparency, more understanding about what companies are doing to make -- to do good in the world.

I think one of the strengths of Brambles is we've always been a good, sustainable company, but it's becoming increasingly relevant now. And I think the benefit of that is not just from our own perspective and how it sits with the regulators or with investors, but with our customers because we're now in a very strong position to support our customers deliver on their sustainability objectives and the need for them to show that they are doing good in the world. And I think in a minute -- I'll talk a little bit more about this in a minute, it's giving us an opportunity to engage with customers and actually deliver more value, nevermind for ourselves, but also for our customers.

One of the questions that we got on the sale of IFCO was when you go ex-IFCO, does that mean all the growth opportunities are going to go away? Now the short answer is, no, but I'll try and expand that a little bit. Yes, we think we've got strong growth opportunities across a multiple of time horizons. We've split them up here into 3 buckets. So in the shorter term, if you look at enhancing the core, there is a strong organic growth. You've seen the slides that Nessa put up in terms of breaking out the price element, but then still a continuing growth coming from converting users of whitewood pallets into pooled solutions. We're expanding new lanes, so doing a lot on first mile and last mile, and I'll come on to one of the products that helps us with them, with last mile in a minute as well as automotive. Notwithstanding in the short term, there's clearly some volatility there. We're also innovating in technology, and I'll talk about that in a minute as well.

In the medium term, we can talk about extending the core, so that's really developing in emerging markets. And we're already investing in Latin America, Middle East, China to a lesser extent and India to a lesser extent. But as we've talked about in the past, over the next 10 years -- 5 to 10 years, we should be seeing some growth in those markets and our presence in them. We're investing in new products and platforms, and I'll talk about that more in a minute, as well as additional services. So we've started already doing things around transport collaboration, but there will be more to come in terms of [distributability] for customers, for example.

And if you go to the longer term, I think we can start looking at creating future business models. So reshaping the pooling model and using the data and the information we get from digital, looking at maybe other insight-based offerings from digital that we can then give to our customers and create value from and then partnering as we've been doing a lot more collaboration in the supply chain, which will also lead us to value opportunities for us and for our customers, and I'll talk about that more in a minute.

But all of this is underpinned by the fundamentals around the need -- consumer growth, the need for more goods to be -- to deliver to more consumers, the development of emerging markets, that underpins all of it. I think the only thing I would say is that we do need to learn from the investments we are making in emerging markets when we go to new emerging markets, and that's sort of something that Nessa has talked about already in terms of what we've been doing in Latin America. We need to continue to learn from those experiences as we go forwards and we will.

So if we look at 4 new sources of value, I'd like to talk about each of these in a bit more detail. And again, we'll talk more about what this means when we get to May next year. The first one is customer collaboration. Supply chains of the future will depend on much more collaboration between, let's say, retailers, the FMCG producers, the 3 PLs and people like us.

I'm just going to talk about Zero Waste World. So this is a collaboration, an initiative we've launched. It's a major initiative where we're partnering with our customers to tackle waste in the supply chain and the inefficiencies that cause the waste.

So there are 3 areas that we're looking at. One is eliminating waste. So just look there, the first box. So how can we help our customers eliminate one-way packaging. So we migrate to reusable solutions. A good example is a large FMCG, who is a customer of ours, were using corrugate packages to transfer raw materials to one of their factories. And we talked about -- and clearly, the corrugate is used once and then thrown away and not recycled. So we suggested that maybe we had some containers, which we actually have as part of our first-mile solution products offering anyway to substitute for the corrugate, save them a lot of money, also save them a lot of carbon miles as well. So there's incredible value to that. It helped us because we, obviously, got new product, new business with that customer.

Obviously, reducing food waste a huge challenge for society, one where we feel we can contribute. If we look at the next one, eradicating empty transport miles, we've talked already about what we started doing a couple of years ago around collaborating with customers. So if you just think about one small fact, in Europe, 30% of every truck, if you think about all the truck miles and all the truck journeys in Europe, 30% of them are empty. So a huge waste of carbon and massively inefficient. So what we are doing, and we've started off doing this more manually with spreadsheets, you start looking at -- because we have the visibility across the supply chain looking at customers that are going one way empty and another customer might be going in the same direction full, how can we link the 2 together so that we optimize the transport efficiency.

So we started doing that manually, took a long time, produced good results. We've now actually managed to get our BXB Digital business to get involved. So they're now using algorithms to do these same calculations and these same matches much more quickly and be able to expand the scope. So it helps with reducing empty miles, it helps with reducing transport inflation and of course, reducing the environmental impact.

And the final one is cutting out inefficiency in the supply chain. So we can work with our customers about reducing bottlenecks in the supply chain and improving the forecasting and therefore, reducing waste.

We are doing all of this not as a thought leader, but more as a facilitator and collaborating. So if you want to think about it another way, this is not about us saying we know everything because we don't, this is about us saying here is a problem that society has to solve. We think we can help in conjunction with other people. And from a more business case perspective, it means that we are effectively taking a small percentage of a much, much larger pie. And of course, we're becoming much more embedded in our customers' businesses. So there's a -- this is not just a philanthropic thing, it is also a business thing.

But so far, we've launched -- we've been doing it for 4, 5 months, amazing response from big customers, amazing attraction, both with those customers and internally within Brambles. So I'm very confident this is going to be a really great initiative. You can see already the fiscal '19 savings both in terms of waste and carbon emissions and that's, I think, probably just the tip of the iceberg.

Brambles led the industry in developing pooling models, but what we want to do is we want to lead the industry in shaping future pooling models. And that's going to require us to think about innovation, both in products and services. So this slide has got a few examples of what we're doing at the moment. The first one is the new European quarter pallet. So that's part of our last mile solutions product offering. So going into convenience stores, for example, or going into a retailer where they want to offer more SKUs to consumers and change things out more quickly than they can do on a full pallet.

It also very much supports promotions. So if you look at some of the bullet points in the right there, I won't go through all of them, but I think some key ones, 100% recyclable and certified as carbon neutral, pretty important, but also it's digital-ready for proximity marketing. So what does that mean? If you have an FMCG in conjunction with a retailer, he wants to, as you walk past, say, you've bought this before or you've bought something similar, how about buying this? We will have the technology on the pallet to work with the promotional marketing that goes on that pallet to attract the consumer in. So this is, again, something we've been trialing for a while, but this is now first of a larger-scale product that's ready to go to market.

Next one, if you look at materials. So we're continuing looking to materials to deliver better performance. Historically, the challenge of plastic has been its high cost and there's a lack of repairability. So if you have something get damaged on a plastic pallet, in the past, you kind of have to grind the whole thing down and start again, it's quite hard to repair a piece of it. So what we're trying to do is to overcome that by a combination of using tracking technology, having a more modular repairable design and of course, pricing to a premium which will help people return the pallets to us because there's obviously -- there is a value in it and clearly makes the maths work better from a financial perspective.

So what have we been doing so far? We talked a little bit about the trials we've done with Costco in the U.S. with a full-size plastic pallet. Those have gone very well. So we're now in the -- at the point of working with Costco to do a much larger scale trial. We're not quite ready to go full conversion, but we've made really good progress on that. We are continually working to try and get the weight down and the cost down.

One of the things that's at the moment is more work in progress rather than something we've got to show the market is a hybrid pallet. And so the benefit of hybrid pallet is it will give you the same structural performance as an all-plastic pallet, but it will be made of a mixture of materials. So maybe some very high-grade wood, so that -- which will be much stronger than regular wood, but also plastic and maybe some metal as well. So the benefit of that is you'll get the same structural performance as plastic, but it should be much lower cost. And that's something we're working on, nothing to show yet, but I would hope that within the next 12 months, we'll be able to talk a bit more about that.

Finally, if you look at collaborative transport solutions. So again, this is something we've been working on for some time. And this is really just to say that we're taking it a step further now by using digital technology to make these estimates and these decisions much quicker and much more efficiently.

So moving on to digital. Again, it's a key part of where we need to go in the future. We've made significant progress in fiscal '19. So we now have BRIX, which, I think, we've talked about before. It stands for Brambles Information Exchange. It's effectively the black box that takes all the data inputs from having -- putting trackers on pallets and other information flows, uses algorithms to make predictions, and that's what it's doing. So we're using that for both internal and external use. We've had some large-scale tracking projects, so full-size pallets in the U.S. We've talked about that with both NPD lanes and with a large retailer. We're looking at asset efficiency pilots in Europe and also doing some customer pilots in Australia and New Zealand.

We've -- so going back to the European half pallet about promotional tracking, we've actually done a trial with Ferrero in Canada about showing them when promotional products come into the retailer. So again, this is absolutely key in terms of FMCG and marketing. You tend to target a 1-week period when your product is promoted at the end of an aisle at a retailer. But to do that, you also plan all the TV and media, promotional and marketing materials to coincide. So -- and if you get that right, you can sell 3x or 4x more of that product than you do normally. So it's very valuable to do it, but it only works if the product is on the shelves during that 1-week period when you're launching all the other marketing. So it's really critical to check whether product is actually coming into the retailer at the right time. And when you look at the data, it often isn't. So this gives a very -- it's a very useful insight for the FMCG producer to go back to the retailer and talk about how to make the promotion more effective.

In fiscal '20, what are we going to do? So we're already looking at larger-scale asset tracking programs. So for example, what we're doing with Costco will be an example, but we're looking at internal ones as well. So how can we get much better bang for our buck and start really moving the dial on the asset efficiency objectives we've got. We're looking, for example, to see how we can use better tracking on our Kegstar kegs. So again, it's a good project to use because there aren't that many of them, but they are very, very high value. So you can see where the -- it's worth having a much better tracking solution there. And we're also looking at how can we use AI and ML, so artificial intelligence and machine learning, to simplify things like customer declarations. I'll talk about that very briefly.

Our model -- our business model is based on cost to serve, pricing is effectively based on averaging hundreds and hundreds of thousands of transactions. And we probably don't get it 100% right. It could be 80% right for the sake of argument. But to do that, we actually require ourselves and our customers to start declaring when assets have arrived at their factories and our premises and when they've left. So it's a huge manual/semimanual process. We have estimated, and I won't talk about it now, how much that costs us and our customers, but we're still working off of averages.

If we could use technology to effectively do away with the need to fill out all those bits of paper and yet still come up with, let's say, as accurate an estimate, so let's say, we still work to the 80% accuracy limit, then the value we would create by eliminating all that cost but still coming up with as efficient a business is pretty big. So we need to work on how can we eliminate declarations using technology, and that's something we will talk about more in May.

Similarly, we're looking at AI and ML. If you think about the sales and operational planning process, it is a lot of people using Excel spreadsheets, using data flows and making estimates, that's all we're doing, making predictions. And AI is misinterpreted by lots of people to mean lots of different things, but in essence, AI all it does is it makes predictions faster than a human brain. That's what it does.

So if we're in a business of trying to make predictions and we're using humans to do it, well, why not use AI and do it quicker and to the same level, if not better accuracy, and that will help us run our business better. Because if you think about what our business is, it's about working out when we need to send pallets to a certain location to get it to a customer, when we should try picking them up. That's what it is, and that's what AI can help us do much better. So we're again trialing that and we'll do more in fiscal '20 on that.

Finally, the fourth area I wanted to talk about was around operations. So we're using technology to enhance what we're doing at our service centers. On automation, we've spoken quite a lot about the program to automate pallet inspection and robotic repair and removal of certain broken elements. We're now accelerating that to look on how we can do robotic repairs. Using augmented realities, we actually can take the operators straight to the right place to repair the pallets and make the whole process much more efficient as well as taking some of the steps in doing them much more automatically.

If you look at plant management, so at the moment, we're just rolling out a program where we're trying to make the whole process of trucks coming in and out of our plants more automated. So using number plate recognition, the truck will come in, all the data, what's on the truck and where it needs to go to next is filled in automatically into our service center system that can therefore get in and out much quicker, much less admin to fill out much more efficiently, and that's being rolled out.

And then, finally, we're looking again just in terms of a work in progress on experimenting how does AI and ML, how can it be used to improve that whole operational planning process.

So just, finally, we're in a strong -- we've made strong progress against the 5 core strategic priorities. We're well positioned for sustainable growth, both in the short, medium and long term. We're setting an ambitious direction to capitalize on what's happened post IFCO and now that we're a much more streamlined focused global business. We're partnering with customers to remove waste and inefficiencies from the supply chain and trying to solve problems that the world needs solving. And we're also, I think, doing a great job around bringing the company together and leveraging our capabilities across the world, which is something we've not always done so well in the past. But we'll do a lot more in terms of showing the details of what we plan to do in the future when we get to the Investor Day in May next year.

So with that, I think we're ready for Q&A. So for those of you -- we'll take questions from the room first, and if you wouldn't mind just saying who you are and where you're from because of the recording, and then we'll move on to questions from outside.

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Questions and Answers

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Niraj-Samip Shah, Morgan Stanley, Research Division - Equity Analyst [1]

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It's Niraj Shah from Morgan Stanley. I just had a question on pricing in the U.S. Obviously, it contributed 3% to the top line in fiscal '19. Inflation seems to be moderating. But on the other hand, you said competition remains rational. And best I can tell, whitewood pricing growth remains robust? So I guess, how should we think about the profile of pricing over the next couple of years as the remaining 2/3, say, of the book rolls?

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Graham Andrew Chipchase, Brambles Limited - CEO, Chairman of Executive Leadership Team & Executive Director [2]

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I think what we're saying in the U.S., I think, we think the profile should stay pretty much as it's been in fiscal '19 because we've still got some more contracts to convert. We're still applying pressure to get price increases as of course, we create more capacity in the market, and that's because there are 3 things. It's the competitor behavior, which seems to be rational still. It's the lack of capacity, which is beginning to open up a little bit as well as our ability to go in and against the high inflation, get price increases. Two of those are going to begin to soften, but our intent is still to go out after price increases in the U.S. So I think we'd anticipate the profile being similar at least in the next 12 months.

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Scott Ryall, Rimor Equity Research Pty Ltd - Principal [3]

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Scott Ryall from Rimor Equity Research. I was hoping that you could give a little bit more detail on the issues in LatAm, particularly if you've got specific countries that are underperforming? And are any below your hurdle rates for sort of return on capital, please?

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Graham Andrew Chipchase, Brambles Limited - CEO, Chairman of Executive Leadership Team & Executive Director [4]

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Do you want to take that one?

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Nessa I. O'Sullivan, Brambles Limited - CFO & Executive Director [5]

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So look, the weighting of the business has always been more weighted towards Mexico. I won't break it down across the specific business units, but Mexico is the biggest part of the region. In terms of overall returns, it's still a high-returning market. The challenge for us is that the normal structure should be, we'd expect to get efficiencies, we weren't getting as it was telling us that the way we were growing the business was going to land us in trouble because we didn't have the right controls to manage the pool appropriately. And a change in management was needed to get somebody with -- they both come from the European business, who had good experience both in operations there but also supply chain and specifically, asset management.

As a group, we also put a lot of the group resources into working with the team across Latin America to develop a detailed plan. They've had access to the best thinking globally from all the markets to help them to develop the plan. We've had our group supply chain lead, Carmelo has been working with them as well as the team in finance and commercial.

And look, from a plan that was developed, we took it to the Board because it required additional investment and overhead to do, it required quite a radical change in approach with retailers. And look, it's been implemented in the second half of FY '19 and to already have such strong outcomes from it is pleasing, particularly because we see there's lots of growth opportunities still in Latin America. We were at a point where we were saying we actually have to get to a point where we can have a trajectory that says this is going to look like other markets when they get to maturity. So when you put more capital in to get the growth level that you're getting better returns. So I would say we're going through a bit of a reset. The pricing only came in, in quarter 4. We left it as amber on the chart until we've collected the pricing from everybody because it involved discussions around if you want to be in these lanes, you have to take a lot higher pricing in these areas. And by the way, we're just recognizing the cost to actually service this business is higher than we previously recognized, and this is the commensurate pricing. So I'd say, going into FY '20, the momentum is good. It's early days, but seeing CapEx to sales come down and have record recollections, we think we're on the right path.

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Scott Ryall, Rimor Equity Research Pty Ltd - Principal [6]

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Okay. So Mexico is the largest business, is that also the largest problem in terms of where you've identified that you're growing? I don't know how -- I don't want to put this the wrong way, but you've not got the controls around your growth profile. Is that the biggest problem area as...

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Nessa I. O'Sullivan, Brambles Limited - CFO & Executive Director [7]

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Well, Mexico, when you think about the region, just Mexico is about half the region. So you should think proportionately. And when you think about stages of development, if it's half, that's the one that should be developing, that's reaching that point that gives you the indications that you haven't got the right systems in place. So the learnings and the changes are across the business, but more focused on addressing immediate challenges with Mexico given that's the biggest piece of the portfolio. So it's a regional management team that's gone in and it's a regional approach.

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Scott Ryall, Rimor Equity Research Pty Ltd - Principal [8]

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Okay. Great. And then the second question is on your plastic trials with Costco. So I assume, Graham, this is yours. Could you just give a sense of why Costco specifically is looking at plastic? And what are the attitudes of some of the suppliers into Costco, please?

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Graham Andrew Chipchase, Brambles Limited - CEO, Chairman of Executive Leadership Team & Executive Director [9]

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Yes. So I think Costco are thinking about it because they're looking at it from a -- particularly if you think about their customers are also -- is much more of a (inaudible) is not the right word, but it's more of a -- it's not sort of someone walking in off the street. You have to become a member of Costco to go in and shop at Costco. So they are very concerned around safety. They're looking at wood pallets versus plastic pallets in an aisle and what's both the hygienic appearance as well as safety. They are, I think, looking at it from also a supply perspective in saying a lot of their products are bulk and heavy, and they have a feeling that plastic is stronger and that's not necessarily the case. It depends, obviously, on the way you've built the plastic pallet. And I think that's one of the challenges, getting the level of performance in high and low temperature because plastic in high temperature bends a lot more than wood and in low temperature, it shatters, which wood doesn't. So this is not a straightforward operational switch. They're looking at that as well.

For us, Costco was a good retailer to go and do a trial with because in terms of cycle time, we knew that their attitude to asset ownership and looking after assets is significantly better than several of the other people we deal with in the U.S. So we knew that if we're going to put some high-value trial assets into their chain, we would get them back and they wouldn't go missing. So that's why we were happy to start with Costco, but as it turns out, it's a -- it seemed to them as being a very strategic move. So it will happen with them.

And the reason we're not doing -- saying it's going to happen is we're not the only player in town. So we have to go in there and prove that we are giving them an asset that delivers on their performance objectives and there will be a point when we have to look at the cost compared to other people who might want to play in that space. Their suppliers at the moment because that's why we're moving now from a smaller-scale trial -- so with a smaller-scale trial, it's with 1 or 2 suppliers, now they want to move to a larger-scale trial where it's multiple regions within the U.S. and multiple types of suppliers. So it's not just in 1 category segment, it's moving across several category segments, both to test out their model, but also for us to see are the economics going to work with more than just 1 type of industry segment. That's why it's now going to a larger-scale trial than going straight from small trial to rollout because I think Costco recognized it's not straightforward either. And that's where we are with that.

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Paul Butler, Crédit Suisse AG, Research Division - Director [10]

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It's Paul Butler from Crédit Suisse. I've got a couple of questions. Firstly, on Slide 17, where you've given the margin improvement targets for the U.S. business. But I don't think you report the U.S. margin. I'm just wondering, just to make some sense of that, whether you can give us some sense of the margin progression that you've seen in the U.S. in '19 versus '18?

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Nessa I. O'Sullivan, Brambles Limited - CFO & Executive Director [11]

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Sure. So if you go to the previous slide, if you flip back to the previous slide, which is on CHEP Americas, which is Slide 14 shows that essentially the -- 1 point of margin decline from the Americas region was delivered was due to the U.S. business, and then you'll see that we expect the outlook, the progression to be the 1 point over the next 3 years, and that's because the major driver of the margin improvement was always going to be from the automation projects and the outcomes from that are largely weighted towards '21 and '22.

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Paul Butler, Crédit Suisse AG, Research Division - Director [12]

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Okay. And then just further on the price increases that you're getting in the U.S., we've had a number of conversations with some of your larger customers. And there seems to be a very concerted effort there for them to try and reduce their usage of pallets to offset price increases. I'm just wondering what you're seeing there and whether you see that as a risk? Because I imagine that there's quite a range of price increases that you're putting through to get to the 9% average.

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Graham Andrew Chipchase, Brambles Limited - CEO, Chairman of Executive Leadership Team & Executive Director [13]

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So I don't think we've seen that because when you look at the growth profile, the like-for-like growth is still there in the U.S. So I don't think -- it's not gone in the wrong direction. And we're still -- obviously, we're still able to convert because the net new business wins is still reasonable. We have been, I think, doing the right thing in terms of price increases, where -- because we are still capacity constrained and will be for some time, where we had businesses, which in our view, were sub acceptable returns, we've gone for quite large price increases. What's interesting is when we are expecting to lose some of that business, we have not lost as much as we expected. So therefore, people are still having to use the pallets I think is the short answer. Now that is not to say for one moment, we are taking the view that maybe was taken in the past, an arrogant view of people have got no choice. We do not -- yes, that's not where we're coming from at all. I think we've recognized that. We still have to improve on quality in the U.S. and we still have to improve on our own operational effectiveness, making sure the customers get the pallets when they need them, where they need them. But I -- we have not -- I've not heard from any customers, that they're saying, we're going to use less pallets because your pricing is too high. Don't get me wrong, they don't accept the price increases willingly and happily, but that's just life. And there have not been price increases in the U.S. market for quite some time. So when we started doing it last year it was the first time for many years.

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Paul Butler, Crédit Suisse AG, Research Division - Director [14]

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Yes. And just further -- I mean, in the last year or so I think you've made progress with Walmart, your biggest retail partner, on reducing flow of pallets out of the country. I just wondered if you can comment on whether you've made any further progress in trying to facilitate a more timely return of pallets from them.

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Graham Andrew Chipchase, Brambles Limited - CEO, Chairman of Executive Leadership Team & Executive Director [15]

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Yes. So the short answer is we've made some progress. One of the things we did with BXB Digital in the last 12 months is one of the trials we did was putting some pallets, digitized pallets into the Walmart flow because, again, we wanted to prove out or not the view that all the problem was due to the continued reuse of pallets from distribution center to stores and back again within the Walmart chain. And we found that a large percentage of it is that, but there is also a percentage, which is not that at all. And the 2 things that we've found were that in some instances, the store manages -- because the last thing they want from their own operational efficiencies is to have empty pallets on the back dock of the store, they were selling the pallets to recyclers, which they are not technically allowed to do. And the other thing we found that was some of the FMCG producers where, in some instance, doing direct shipments of products to the store, run through DC which is fine, but they've been instructing either tacitly or not the drivers if they were empty on the way back to pick up a load of pallets and take them back to the FMCG producer. Now in the U.S. model, that's not good news for us because we only get to issue a fee or to charge people when we issue a new pallet. If we don't even know whose pallets are being brought back into the FMCG, we can't charge for it. So finding those 2 things out is really important. We've now been able to go back to Walmart. And Walmart, the issue is really that it's not an integrated organization. So the logistics people aren't necessarily the same people who run the stores. So we're beginning to have a dialogue now, saying, can we now talk to the store organization about what they're doing with recyclers. Can -- and we're now able to talk with some of our customers and say actually technically you're not allowed to do this. So we are making progress. We're also getting progress from Walmart in terms of understanding the need to sweep their stores more regularly and get the pallets back to us. So yes, but we're not seeing it in the numbers yet because it's a huge organization, but from a direction of travel, I think, we're going in the right place.

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Paul Butler, Crédit Suisse AG, Research Division - Director [16]

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Okay. And just another one. In Canada, you're highlighting that you've got extra costs because of the dual pallet pool and also because of the higher damage rate to the block pallets. And I just want to drill that across to how we think about what happens if plastic becomes a bigger part of the pool. So obviously, plastic pallets are more expensive, so you need more pricing to cover that. But then you also end up with a dual pool. Are you confident that you're going to get the pricing to match the level of returns you've got elsewhere in the business?

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Graham Andrew Chipchase, Brambles Limited - CEO, Chairman of Executive Leadership Team & Executive Director [17]

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So I mean, since it's not just a pricing issue, it's also about what's your assumption around damage rates and loss percentage, it's a number of different factors, which then can lead you to making sure you've got the right returns, and that's why this next scale, larger scale pilot is quite important because that will be when we can start testing our pricing assumptions with the supplies into the Costco supply chain. Looking at on a piece of paper and what we think we can do in terms of recognizing that there's quite a big premium for plastic pallets. It look like -- it looks like it's still okay. Will it be necessarily as high a return as wooden pallets? Possibly not. But the alternative is to do nothing and let somebody else do it, which I'm not sure is a good answer. Or Costco find a completely different solution, which is not a good answer. So as long as it's above cost of capital, then I think that would be the right thing for our business and our shareholders. Clearly, we want to optimize that, and that's where I think the trial is important around pricing, but also checking our assumptions on loss and damage because we've only done it with effectively one supplier, one lane into Costco, and we need to check out the assumptions. But it's a key thing.

And then I think the other thing we said before, as that -- let's assume that gets scale and it's not -- maybe not just Costco, it might go elsewhere in the U.S. business. We then got to manage different -- maybe different types of service centers, different repair processes, different wash processes and manage the transition. Now if we've got the growth in wooden pallets given -- and also understanding the life cycle, I think it's manageable unless there's a big switch, I don't think there will be a big switch in a short period of time. So I think it's manageable, but something we have got to think about for sure.

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Unidentified Company Representative, [18]

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Are there any more questions on the floor? No. If there's not, we'll go to questions from the phone.

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Operator [19]

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(Operator Instructions) Your first question comes from Matt Ryan with UBS.

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Matthew H. Ryan, UBS Investment Bank, Research Division - Executive Director and Research Analyst [20]

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Just sticking with plastic. Can you talk a little bit about the tracking technology that might be applied to these plastic pallets?

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Graham Andrew Chipchase, Brambles Limited - CEO, Chairman of Executive Leadership Team & Executive Director [21]

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Yes. So I think what's most likely is it's going to be an RFID type of solution. And to that end, Costco already looking at the investment they would have to make within their own network in terms of installing scanners because it's all well on us sticking an RFID tag on a pallet, but that will -- you can only read it when it comes into contact with a scanner, and that requires, therefore, scanners within our service centers, but also within the DCs and stores at Costco. And they are prepared to make that investment because I can see the benefits of doing it. So that -- I think that's where we'll end up, but we haven't finalized it yet, but that would be my gut feel is it will be an RFID type of technology.

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Matthew H. Ryan, UBS Investment Bank, Research Division - Executive Director and Research Analyst [22]

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So I guess, looking at the trials that you've conducted so far, if we were to assume that some sort of passive RFID was applied to those. I mean, are you expecting the loss rates under this broader, I guess, larger pilot will be pretty similar to what you got in the trial?

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Graham Andrew Chipchase, Brambles Limited - CEO, Chairman of Executive Leadership Team & Executive Director [23]

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Well, that would be -- if it wasn't, we would have a -- I think, we would have a different view on pricing. As I said because the things are linked. The Costco and the people who are helping them on this project have been incredibly proactive and supportive in trying to close off all the areas of potential leakage. And so we've sat down not only from the results of the small trial but looking at the system as a whole and identifying where we think there are areas of potential leakage. They've gone in and said, okay, well, if we do this, this and this, that should close it down. So this is definitely a joint effort because they understand that for us to make this work for us, they have got to help us manage the loss rate so -- and the damage rate as well. So they've been very, very constructive and collaborative in this process.

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Matthew H. Ryan, UBS Investment Bank, Research Division - Executive Director and Research Analyst [24]

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Okay. And I mean, just flipping to price in the Americas, I think the effective price increase in the U.S. was about 4% over the year, which implies about 3% in the second half. Can you just talk through, I guess, what happened with the surcharges? It doesn't look like you've got much of a benefit from surcharges in the second half.

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Nessa I. O'Sullivan, Brambles Limited - CFO & Executive Director [25]

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If you go back to actually look at the recovery levels and the margin impact year-on-year into -- in the -- on the margin, first half, second half, you can see we did get good recoveries. But obviously, as you start to see a lower rate of inflation, you get lower recovery. But year-on-year, the net impact despite an increase in inflation, we had a full year impact this year of $10 million across the group, which is down from $18 million in the prior year. So you can see we were getting a benefit, which is partly driven, that net number is reflecting the surcharges. We have certainly increased over the year, progressively, the surcharge clauses in contracts in the U.S.

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Matthew H. Ryan, UBS Investment Bank, Research Division - Executive Director and Research Analyst [26]

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Sure. I guess, I'm just looking at the first half numbers, where I think you said you had effective price growth of 5%, of which 3% was price, 2% was surcharges. And I think you said in the second half -- or sorry, for the full year, you've also had a price increase of 3%, but your effective price went up 4%, that's sort of June 1, all of the growth in the effective price in the second half was actually just price change rather than surcharges?

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Nessa I. O'Sullivan, Brambles Limited - CFO & Executive Director [27]

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Well, it depends on also your mix of business that you have in the first half versus the second half. So in the second half, we actually had quite a bit of beverage volume, which is, again, a lower price that gets included in your total pricing of what we would have reflected. So it depends on the contracts you're renewing. So the bigger contracts, in general, having more market power would have a lower average price increase compared to the -- say the smaller contracts. So there is a big mix impact. I would say in the second half also, we had a bit of a lower mix of agricultural flows. And that was because as we went, we won a very big contract that required a lot of pallets that was in the last quarter of the year, but we hadn't quite exited some other contracts that were on a lower [OPI], but we didn't pick up some of the agricultural flows that we would normally pick up seasonally because our -- we had our pallets tied up. So I wouldn't read too much into the first half, second half, that we haven't continued to get pricing.

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Matthew H. Ryan, UBS Investment Bank, Research Division - Executive Director and Research Analyst [28]

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Okay. And just last question on transport inflation. I think the guidance is ongoing inflation in all markets, which includes the U.S. Can you just talk about how you're taking in account of, I guess, improving rates that we're seeing in the spot and contract indices that we can see publicly?

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Nessa I. O'Sullivan, Brambles Limited - CFO & Executive Director [29]

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Yes, definitely. So you would be a brave person to call where the inflation is going to end for the year based on what we've seen to date. But yes, we have seen a moderation. And if we continue to see those low rates continuing during the year, we will get some benefits from them. So absolutely, we'll be tracking that very closely, part of our portfolio is on spot. We generally even for fixed contracts tend to be pretty sophisticated on how we buy. So yes, we're keenly focused on that. But the view currently going into this is that we'd expect to still see some inflation. Let's see where we go in the first half.

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Operator [30]

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Your next question comes from Owen Birrell with Goldman Sachs.

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Owen Birrell, Goldman Sachs Group Inc., Research Division - Metals and Mining Company Analyst [31]

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Just a few questions for me. I'll just start with the U.S. pallet margins. Great slides, I guess, again, just showing where you think you can recover margin in the U.S. market off those first half '18 levels. But given you don't split out what the U.S. margins are in the first place, I'm just wondering how are we supposed to measure that?

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Nessa I. O'Sullivan, Brambles Limited - CFO & Executive Director [32]

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Well, everything that we put into our ASX slides is QA-ed. So we have -- I can tell you, a mound of people who double check all the facts and all the analysis. And our auditors review the comments that we make as well. But we do have a very detailed review that we -- and we keep an audit trail of all of this to confirm that what we're communicating to you is exactly in line with how we did the calculation in the first place. So there is a very rigorous internal process. But we're not going to start reporting U.S. as a separate business. We're reporting in the regions as we have done and we'll continue to do. But I guess we've gone above and beyond the way we break up the segments because we are trying to guide people and help you to kind of get there, and we've added additional notes as well in the accounts even for the changes in IFCO. But we do have a rigorous process and you should have comfort around that.

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Owen Birrell, Goldman Sachs Group Inc., Research Division - Metals and Mining Company Analyst [33]

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Okay. So if we...

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Graham Andrew Chipchase, Brambles Limited - CEO, Chairman of Executive Leadership Team & Executive Director [34]

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In the call, I think you referenced back to that sort of Investor Day comments. So it does hang together. Because I think what we said was, if you take the margins at the end of the first half of '18, we said, well, we think they're going to go up 2-ish percentage points, maybe 2 percentage points to 3 percentage points. We since gone down 1 percentage point, which is, therefore, still consistent with us saying we think we're going to go up about 2 percentage points to 3 percentage points between now and the end of '22. So I think -- and so I think it's consistent where you're obviously talking about is it 2 percentage points, is it 3 percentage points, is it somewhere in between. But I think we're -- it still hangs together, given we've gone down 1 percentage point since the -- in fiscal '19.

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Nessa I. O'Sullivan, Brambles Limited - CFO & Executive Director [35]

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And if you have a look at the bottom of the slide, we've also footnoted so that you know you're comparing like with like to clarify those points.

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Owen Birrell, Goldman Sachs Group Inc., Research Division - Metals and Mining Company Analyst [36]

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Let me just draw this another way. North America as a group, first half '18, 16.2% was the margin then, are you sort of implying that you can add sort of what, 200 to 300 basis points on that to get you back up sort of 19%? Given issues in Canada and LatAm, can you get to that level?

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Nessa I. O'Sullivan, Brambles Limited - CFO & Executive Director [37]

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We're talking about the commitment here has to do with the U.S. pallets, and that's why we break it out to the U.S. pallets.

So we've talked about Latin America, and we're taking new pricing that's just coming in quarter 4. I would expect that the level of the IPEP charge should be able to come down over time in Latin America because we'll be going into lower risk flows, which means you have to expense lower -- lower charge in relation to those flows. But we have to see both those impacts flow in, that's going to be a 3-year program.

In relation to Canada, we recognize when we go to block pallets, there will be a higher damage rate that will be ongoing. You're getting a softer wood with 4-way forklift entry, which means that they get more damage because usually the corners they -- that get damaged, the stringer is a lot more robust. So we just want to signal that we've come from a position that our Canada business was particularly a very high return business. The competitors also have block pallets. So we don't have a lot of room to say we're going to charge more because the block pallets gets higher damage. So we're limited in terms of commercially what we can do. So we're saying expect there'll be some moderation in margins in Canada from an ongoing basis relative to where we've been historically. Latin America from where we are now, we'd expect some improvement. And the U.S., we expect improvement by these quantums.

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Owen Birrell, Goldman Sachs Group Inc., Research Division - Metals and Mining Company Analyst [38]

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Okay. All right. Just another question, just looking at plant costs, they rose through the period as well. You called out increased inefficiencies. You also note that the U.S. automation programs are at 50% now, with 20 out of 50 sites. Just wondering, did automation actually have any positive impacts during the period? Or is it still going through commissioning and you're facing those sorts of difficulties?

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Nessa I. O'Sullivan, Brambles Limited - CFO & Executive Director [39]

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No, not really, because -- it's not really. And that's why we've always said it's going to be weighted to '21 and '22. Because as you go through, you take plants, you take capacity -- so we started off where we didn't have enough capacity. So when you get to a point where you're capacity constrained and then you're taking capacity out that means you end up with a lot of rehandling, reworking. Your plants are not working efficiently because you're stretching them to use every last piece of capacity, you're running overtime in them. It's not an efficient way to run a network. And then you overlaid that we've had a lot of inflation on transport. So then you get sort of doubly hit because the transport costs ping you for the additional moves. So you start with not having enough capacity and then you take capacity out. So as you progressively, so you think we've done 20, we're doing another 17 this year. So that inefficiency doesn't really start to fall out until you get to the '21, '22. So that's how you should think about it.

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Owen Birrell, Goldman Sachs Group Inc., Research Division - Metals and Mining Company Analyst [40]

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Okay. And can I just ask on the capacity constraints, I mean, you've -- Graham, you called it out a couple of times during the presentation. Is that affecting the service quality standards to the customers in terms of being able to deliver the customers the pallets when and where they want?

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Graham Andrew Chipchase, Brambles Limited - CEO, Chairman of Executive Leadership Team & Executive Director [41]

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It's not affecting the quality because we're making sure that we keep on investing in the quality of the pool, even though we're obviously struggling with margins in the U.S. at the moment. So we've not relented on the investment in quality. I think it does make it harder for us to deliver the right pallets at the right time to the customers, but that's where we're effectively heating that up, as we just talked about in terms of network inefficiency. So we're not -- and then if you look at the customer surveys we do and the Net Promoter Score, they've actually been improving in the U.S., so that implies that we're doing it better than we were before, even if it's not necessarily at the levels that we or the customers would want it to be.

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Nessa I. O'Sullivan, Brambles Limited - CFO & Executive Director [42]

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Yes, one of the other factors we're seeing too is in the U.S. a lot with the big-box e-commerce guys are the access to labor, labor churn is an added cost that we've got that's an increased inefficiency or increased cost we're also bearing.

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Owen Birrell, Goldman Sachs Group Inc., Research Division - Metals and Mining Company Analyst [43]

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And I'm just wondering, are you seeing any increased rates of churn as a result to competitors?

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Nessa I. O'Sullivan, Brambles Limited - CFO & Executive Director [44]

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Sorry, can you say that again?

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Owen Birrell, Goldman Sachs Group Inc., Research Division - Metals and Mining Company Analyst [45]

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Are you seeing any increased rate in churn of contracts to your competitors as a result of that capacity constraint?

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Nessa I. O'Sullivan, Brambles Limited - CFO & Executive Director [46]

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No, no, because we're managing it by effectively putting in more costs. So we're easing extra overheads. We're easing the extra transport costs and ideally in fact as we've gone through the portfolio, we had a number of customers where we won a big customer and we were losing a couple of other customers. And actually, the ramp down of those customers was slower than ideally we would have liked for pallet efficiency. And that's why in the second half, we bought more pallets in the U.S. than would be ideal for that network. So no, we're not seeing that.

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Operator [47]

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Your question comes from Jakob Cakarnis with Citi.

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Jakob Cakarnis, Citigroup Inc, Research Division - Associate [48]

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Nessa, just to pick up on the efficiency point, I think you mentioned there that you're purchasing more pallets to service customers in the U.S. I noted that there was a change to asset efficiency metrics for the managers. Can you just talk to the runway of how we get improved churns from here, just noting the delays that you're seeing on the (inaudible)

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Nessa I. O'Sullivan, Brambles Limited - CFO & Executive Director [49]

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So look, first of all, I think you can look at cycle times, but there's always a question about what impacts cycle times. So we've actually said the fairest measure is using CapEx to sales because in a higher cost inflation, the pallets are going to cost you more, but you should be charging more for them. So a better mix, a better ratio to judge people by. We've seen some improvement, if you x the Brexit adjustment, the pooling CapEx to sales is about 20%. We would say that as we -- the progress we've made has been smaller than we would have liked on the CapEx to sales. You'll see on the CapEx slide, we split it out, so you can see how much efficiency we're actually getting. So we analyze the root cause of what drives all the components including how much is due to Brexit, how much is due to CapEx to lumber inflation, for instance. So we're using that -- that measure change of using it as a percentage to sales, we feel is a more appropriate fit. We would -- we've also split out automotive to see -- so you can see the level of investment that relates to that and you get a sense of the improvement. We see this as an area where we would say, over the last few years, we saw -- we see this as an opportunity. And we have made some improvement. We haven't really got to the full place that we can get to. We see that there are further improvements that we're already seeing, say, in Latin America from the collection processes and other things. We're trying to use pricing levers in other markets where we're trying to better align prices with cycle time and use of assets to incentivize people to have the pallets for less time, give them back quicker. So we still see that opportunity. We've more work to do as well in terms of using digitization and some of the bigger trials, hopefully this year, should help us to do that.

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Jakob Cakarnis, Citigroup Inc, Research Division - Associate [50]

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Okay. I'm just pivoting now to Slide 17, where I think everyone's been focusing on this U.S. pallets margin outlook. At the Investor Day, there is a view on this 200 to 300 basis point margin improvement that also included, I guess, some downside from cost inflation. I was just wondering whether or not the views remain consistent given the pullback in cost inflation that you guys are pointing out happened in the second half of '19?

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Nessa I. O'Sullivan, Brambles Limited - CFO & Executive Director [51]

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Yes. So look, the comment that I made earlier, I'd stick by that comment to say, look, our current view is that inflation will continue to be a challenge for us. And we've always said that when inflation is continuing to rising, there'll always be a little -- there will be a lag to catch up. But if inflation moderates, and we continue to see -- if we do see deflation, then yes, you should expect us to see -- to get some benefits. And there will be some timing benefits that you get, the same way we've had some adverse timing impacts as the inflation has increased. But our current view is it's going to continue to increase. If that changes and the actual outcome is that it's not increasing, then yes, we may be looking at a different profile over time.

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Jakob Cakarnis, Citigroup Inc, Research Division - Associate [52]

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Okay. So just on Slide 17, where you were saying that the phasing of the improvements will be about 100 basis points from '20 to '22. Is that solely from the self-help initiatives and kind of ex inflation? Or does that include a view on inflation at the moment?

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Nessa I. O'Sullivan, Brambles Limited - CFO & Executive Director [53]

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It includes. So if you look at where we're saying, we think we get a point of improvement for each year for FY '20, '21 and '20 (sic) ['22,] it's a combination of all of these items together.

If inflation comes down, we don't get the full win because the surcharge comes off as well. So you just got to be conscious that when we were going up, we had the raw costs coming in where we didn't have the surcharge, we've been catching up with surcharges. As you come down, you'll have a bit of a timing benefit from when it comes off and your surcharge is still on. But net-net, over time, you will get the surcharge comes off as well as inflation coming down. So it's a net number that you're looking at probably on the benefit side as opposed to on the way up, where we have a raw increase in costs.

The other inflation that we talked about as we think -- as you look going forward is we are seeing property inflation, we're seeing warehousing costs, particularly service center costs go up. And again, big-box retailers have been a big impact on that. And if you look, I guess, to the U.K. and other parts, you're seeing the Brexit-related warehousing costs go up. And we have seen that impact now starting to come through too on labor.

So I agree with you. We're seeing lumber moderate, which is CapEx, we're seeing -- starting to see some early signs of transport, but we still would have some property and potentially labor challenges.

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Operator [54]

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Your next question comes from Cameron McDonald with Evans & Partners.

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Cameron McDonald, Evans & Partners Pty. Ltd., Research Division - Head of Research [55]

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Just some clarification questions, if I can. Just -- so -- and you mentioned the -- that you feel that the CHEP USA margins had declined by 1% since the first half '18, is that -- did I hear that correctly?

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Graham Andrew Chipchase, Brambles Limited - CEO, Chairman of Executive Leadership Team & Executive Director [56]

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In '19, in fiscal '19, they've gone down 1% -- 1 point.

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Nessa I. O'Sullivan, Brambles Limited - CFO & Executive Director [57]

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1 point in terms of the Americas region impacts. So if you -- it's set out on Slide 14. So you'll see that the annual impact from the U.S.A. on the region is just over 1 point, with Canada and Latin America making up the balance, and you'll see the relative improvement in the U.S., say, half 1 to half 2 and part of it's due to improved recovery of costs, which is due to surcharging. And part of it is also due to more favorable comps. If you remember, in the first half of '18, we didn't have the high inflation, therefore, you'd expect, as the U.S. cycled, that with higher inflation, it would have a bigger impact on the year-on-year margins.

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Cameron McDonald, Evans & Partners Pty. Ltd., Research Division - Head of Research [58]

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Yes. So just to be clear that you are highlighting that the benchmark is now based pre the accounting changes at 16.2% and the Americas for the -- sorry, the U.S. contribution to that 16.2% is the benchmark?

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Nessa I. O'Sullivan, Brambles Limited - CFO & Executive Director [59]

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We're going back to the absolute margins of the first half '18, and we'll continue to measure it on a like-for-like basis, adjusting so that the accounting changes do not impact it. So it will be the real margin outcome that we're measuring.

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Cameron McDonald, Evans & Partners Pty. Ltd., Research Division - Head of Research [60]

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Yes. Okay, great. And then can you give us an update on where you are with the Kohl's RPC contract in Australia, please.

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Graham Andrew Chipchase, Brambles Limited - CEO, Chairman of Executive Leadership Team & Executive Director [61]

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Not really, because we've actually signed some confidentiality terms with that negotiation. So there's nothing I can say on that.

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Cameron McDonald, Evans & Partners Pty. Ltd., Research Division - Head of Research [62]

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Is there any timing related to that decision?

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Graham Andrew Chipchase, Brambles Limited - CEO, Chairman of Executive Leadership Team & Executive Director [63]

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There is nothing I can say on that.

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Cameron McDonald, Evans & Partners Pty. Ltd., Research Division - Head of Research [64]

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Okay. And then sort of with the plastic trials into Costco, when is the sort of -- is there a decision point about the go or no go and what the potential capital requirements could be?

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Graham Andrew Chipchase, Brambles Limited - CEO, Chairman of Executive Leadership Team & Executive Director [65]

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Well, there will be, but that's -- that will be down to Costco, and I think they will have to look at the results of the trial from an operational perspective. And if it's in line with what they are hoping for, then I think they would look for various suppliers to put in -- put out an RFP and will go through a normal process. And then our decision will be, do we think we want to take on all the business, we will be allowed to take on all the business, if I were Costco, and I suspect this is where they're coming from, they'll have more than 1 supplier because that just makes business sense. And then it will be a question about to what extent can we say we think our products is better suited to certain lanes or certain regions. So it's very, very hard to call on what the CapEx will be until we actually get into a more detailed negotiation post this large trial. So that's not going to be -- we won't know -- we won't be in that sort of -- that phase for at least the next 9 months, 12 months, I would have thought.

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Cameron McDonald, Evans & Partners Pty. Ltd., Research Division - Head of Research [66]

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So are you the only supplier in the larger trial? Or are there other suppliers that they're bringing into that trial that potentially that you're potentially going to have to share...

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Graham Andrew Chipchase, Brambles Limited - CEO, Chairman of Executive Leadership Team & Executive Director [67]

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So Costco today have 3 pallet suppliers. And I'm sure all 3 will be involved in the trial, and it's not something we're made aware of, but I would be extremely surprised if all 3 were not involved in the larger trial.

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Cameron McDonald, Evans & Partners Pty. Ltd., Research Division - Head of Research [68]

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And then, how are you protecting your IP under that trial then, if you've got other suppliers involved?

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Graham Andrew Chipchase, Brambles Limited - CEO, Chairman of Executive Leadership Team & Executive Director [69]

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Well, our pallet has got IP, and that's IP. I mean, it's our pallets, it's our IP and similarly, the other suppliers will probably have their own pallets and their own IPs. And therefore, one of the challenges, but -- there might still be a good commercial reasons for doing it is that you'd be running, if you were Costco, a pool or we -- or the poolers would be running the pool, but you would have different pallets within the pool, but that's sort of not that different to where they are today in terms of having to sort different. At the moment, if you look at the Costco pallets that are used in their business, they've got a mixture of woods and plastic, 3 different suppliers. So it's the same sort of operational challenge that they've got today.

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Operator [70]

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Your next question comes from KyVan Tang with Colonial First State.

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KyVan Tang, Colonial First State Asset Management (Australia) Limited - Co-Lead of Credit Research [71]

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All my questions relate to Brexit. So can you expand in greater detail what these Brexit-related inefficiencies are? And are they just impacting your U.K. business or are you also seeing an impact in your Mainland European business?

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Graham Andrew Chipchase, Brambles Limited - CEO, Chairman of Executive Leadership Team & Executive Director [72]

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So the inefficiencies we're seeing at the moment are related to customers wanting to stockpile ahead of what they think is going to be hard Brexit. So we saw that leading up to March, which is when the first deadline was going to be, and that's when we end up putting more CapEx and because clearly, customers want to stockpile product, the pallets are not moving through the system, we're having to inject more CapEx. Now that in theory is a temporary issue, not a long-term issue because when they stop stockpiling and the pallets are released back into system, which is what's happened since March. But now we have the next deadline coming up, which could be -- someone is smiling in the audience, yes, it could be the end of October, it could be any other time, I guess, as well, where again we expect customers to want to stockpile. The slightly different element now is that if it is the end of October that's also the time when customers need to be preparing for the Christmas surge. So it's probably going to be an exacerbated issue in terms of having to put more CapEx into the business. So that's one element.

The other element though is around the heat treatment of pallets, which if the U.K. leaves the EU, at the moment, pallets going backwards and forwards within the EU are treated as being okay from a bug perspective. If the U.K. comes out of the EU, all of a sudden our bugs are clearly very dangerous bugs to the EU, and we have to prove that we've heat-treated everything. So that means we need to invest in heat treatment in our U.K. plants, which we are doing. So there's a bit of CapEx there as well.

I think just to put it into perspective though, only 10% of our European business flows are U.K. cross-channels. So yes, it's a major irritation, but it's not a dramatic thing. The bigger issue as far as -- and I don't think it's necessarily -- there's no evidence to support it's affecting our non-U. K. business today. You could argue that the slowdown we're seeing in France, in particular, is probably impacted by some Brexit uncertainties around the ports and the flow of goods. I mean, you could. I don't think there's hard evidence to support that. The bigger issues are going to be, I think, the slowdown of GDP in Europe, and that is driven as much by the fact that Germany's economy is an export economy and therefore is affected by China and the U.S. France's economy is also slowing down. Italy's is slowing down. So I think these are far bigger issues in the context of Europe. I think the bigger issue from the U.K. perspective is the political change that may or may not happen as a result of Brexit being effected with or without a deal and people far more intelligent and better paid than I are still not able to answer that question. So I just have no idea what the outcome of that is. But for me, that's actually the bigger issue. But I don't think we can plan for that. We have to do what we could control. And what we are doing is effectively talking to our customers. We've been -- we've spent a lot of time talking to over 100 customers about understanding what their plans are around Brexit. So we can either support them or at least understand what the requirements might be, talking -- thinking about the heat treatment, but also lobbying the government around making sure that if we have a hard exit that there's going to be some grace period around having to effect some of these changes, and they've been very supportive of that. So those are sort of the things we can do.

The other items I think are becoming less of an issue. I think we were worried at one point about flow of labor over -- across the border. I think that might be okay. So certainly, I think we're doing everything we can. It's an incredibly difficult thing to forecast, but we are taking a view that there's going to be a hard exit and that's what we're planning for because that's obviously the most impactful scenario to plan for.

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Nessa I. O'Sullivan, Brambles Limited - CFO & Executive Director [73]

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So I think all of Graham's stuff are sort of definitely the bigger picture and the bigger potential impact. But in this year, we also had a lot more pallet relocations. So there were -- we also relocated pallets back to Mainland Europe for exports back to the U.K. on U.K. pallets. We also -- because there was a big demand for that U.K.-type pallet, we also accelerated repairs on any of those pallets because there was particular high demand for that U.K.-type pallet. So there was some impact as well on this year when we talk about Brexit operating inefficiencies, but obviously, Graham's covered the bigger strategic issues and potentially bigger financial impacts.

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KyVan Tang, Colonial First State Asset Management (Australia) Limited - Co-Lead of Credit Research [74]

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Great. And you're saying you're prepared for it. Have you done any sort of scenarios as to what, a no-deal Brexit would mean for you in terms of cost? Or is that too hard to get into at this point?

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Graham Andrew Chipchase, Brambles Limited - CEO, Chairman of Executive Leadership Team & Executive Director [75]

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Well, we have planned for -- so we're planning for no-deal hard Brexit. And in reality, what is the -- the impact is going to be around potential tariffs on pallets coming into the U.K., which are manufactured -- obviously, be purchased from outside of the U.K. It's probably one of the bigger ones. And then the solution is not easy, but there is the solution do we go and buy more pallets from inside the U.K., it's not like the U.K. doesn't have any woods since that we've been buying them from outside of the U.K. for a while. So that's something we can look at. So in terms of is that going to be a big cost impact? We don't think so. There are some things we're going to have to do differently. What happened? I think the impact is more likely to be on our customers, if there's lots of tariffs on goods. I think something like 30% of the U.K.'s food is brought in from outside of the U.K. That is going to have a bigger knock on for consumers and for our customers. We don't see it as a huge financial issue for us. It's something we just have to think around.

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KyVan Tang, Colonial First State Asset Management (Australia) Limited - Co-Lead of Credit Research [76]

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And then finally, are there any break clauses in your existing contracts with customers that are directly related to Brexit, such that if there is an ideal Brexit, they have the opportunity to, like, renegotiate the terms of those clauses or break it off completely?

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Graham Andrew Chipchase, Brambles Limited - CEO, Chairman of Executive Leadership Team & Executive Director [77]

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Short answer is no. I guess, you'd have a debate around whether it was force majeure, and I think most commentators think that this is not force majeure. So I think that's not something we are particularly worrying about at the moment.

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Operator [78]

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There are no further questions at this time. I'll now hand back to Mr. Chipchase for closing remarks.

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Graham Andrew Chipchase, Brambles Limited - CEO, Chairman of Executive Leadership Team & Executive Director [79]

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All right. Well, I think we've gone on quite a long time. So thanks for the questions. And I'm sure we'll be seeing some of you in the next few days. But thank you very much.

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Nessa I. O'Sullivan, Brambles Limited - CFO & Executive Director [80]

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Thank you.