Why defensive Brambles is rallying like a growth stock

When you think about Brambles (ASX: BXB) – a company that manages the world's largest pool of reusable pallets, crates and containers – you'd characterise it as a slow moving stock that appreciates maybe 5% every year, with defensive earnings and a reasonable dividend yield.

And that's pretty much been the case. The stock's up around 98% in the past decade (2013-2023), with an average annual dividend yield of 2.9% and EBITDA growth of around 5.4%.

But uncharacteristically, it's rallied 16% in the last two sessions.

Brambles 5-year price chart (Source: Market Index)

Unexpected Growth

Brambles is a fairly boring and predictable business. Brokers and analysts would have a pretty good idea of what numbers they're going to report based on data points like global trade, volumes from key customers, lumber prices etc.

But the company's FY24 earnings absolutely crushed market expectations (estimates refer to Morgan Stanley forecasts prior to the result):

• Sales up 8% to US$6.54bn (in-line with estimates)

• Operating profit after tax up 19% to US$778m (4.7% beat)

• Total FY24 dividend of 34 US cents (17% beat)

• FY25 underlying profit growth guidance between 8-11% (vs. 7.2% estimates)

While it's fairly normal for a growth stock like Wisetech Global or Life360 to beat analyst estimates by 4-17%, it's very rare to see a defensive name like Brambles to report a beat of this magnitude.

Unexpected earnings beats often trigger analyst upgrades, attract inflows from growth and income funds, while retail investors jump in to capitalise on the newfound momentum.

Bullish Broker Response

Most brokers were Buy or Neutral rated in the lead up to the result. But the magnitude of the surprise has forced them to hike their target prices. Some of the key changes from major investment banks include:

• Citi upgraded to Neutral from Sell; target price up 21.7% to $17.35

• Goldman Sachs retained a Sell rating; target price up 10% to $17.35

• JPMorgan retained Overweight; target price up 8.0% to $18.80

• Macquarie retained Outperform; target price up 9.8% to $17.85

• Morgan Stanley retained Overweight; target price of $20.00

• UBS retained Buy; target price up 9.7% to $19.10

The above brokers raised their target prices by an average 11.8%. Even the most bearish of brokers (Goldman Sachs) lifted their target price up 10% to reflect the stronger-than-expected growth numbers.

Is It Too Expensive?

Brambles is now trading at a price-to-earnings ratio of approximately 20 compared to 16.5 at the beginning of the year. Looking at this change in isolation suggests that the stock has become more expensive (on assumptions of more growth).

While analysts were universally positive on the result, there was some caution regarding the stock's valuation. Macquarie said the price tag can be justified given its cash generation. While others expressed concerns that the recent rally might limit upside potential.

From a historical perspective, Brambles is trading towards the upper bound of recent averages.

Source: Macquarie Research August 2024

When compared to the broader ASX 100, Brambles has historically traded at a 15% discount to peers.

Source: Macquarie Research August 2024

Brambles delivered an impressive result, driven by multiple factors: Enhanced asset efficiency, improved pallet availability, and easing inflationary pressures. The company not only beat expectations but also announced a US$500 million share buyback program and increased its payout ratio from 45-60% to 50-70%. While the result and guidance was undoubtedly positive, it's worth noting that its price chart is looking quite vertical after the past two days.