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Tennessee Whiskey: The Ultimate Profit Machine

Patricio Kehoe

Patricio Kehoe

7 followers

It’s known that American brown spirits are provided throughout the world by very few companies, such as Diageo Plc (ADR) (DEO) and BEAM Inc. (BEAM). However, while these firms focus on Scotch and Bourbon, Brown-Forman Corporation (BF.B) holds the leading market share of Tennessee Whiskey via its famous Jack Daniel’s brand. Despite a distribution scale six times smaller than Diageo, this beverage manufacturer has the most solid balance sheet in the industry, and the longest market presence with its 142 years of family owned business experience. Thus, investment gurus like Steven Cohen (Trades, Portfolio) and Murray Stahl (Trades, Portfolio) recently added more of this company’s shares to their portfolio, hoping to gain future profits. A bet well placed, in my view.

A Tennessee Crown Jewel in the World

Now, the fact that aged spirits with known brands benefit from a very loyal customer base and barriers to entry is a positive factor for each of the aforementioned industry players. However, Brown-Forman’s portfolio of 25 brands, including Finlandia vodka (9% of volume), Southern Comfort (6% of volume), El Jimador tequila (18% of volume) and Korbel champagnes (4% of volume) are sold in over 135 countries, with half of all revenue attributable to domestic sales. But the Jack Daniel’s brand (50% of overall volume) is and will continue as the company’s premium growth booster, spotting a 10% increase in year-to-date underlying sales. Although this figure is surely supported by the general consumer shift from beer to spirits, the recent gains in international markets and small targeted acquisitions have contributed to this success.

Furthermore, management’s effort to bolster the brand with product extensions, such as Jack Daniel’s Tennessee Honey, Gentleman Jack and Jack Daniel’s Single Barrel have helped boost sales significantly, making the brand an absolute market leader. Another favourable aspect of Forman-Brown is its efficient global distribution network. While the firm sells its products to wholesalers in the U.S., sales in the UK are combined with Bacardi’s brand portfolio, and the partnership with Coca-Cola Hellenic Bottling Co. SA (ADR) (OCCH) handles distribution in Russia, Ukraine, Croatia and Hungary. This scale system, combined with the strong brands and difficulty to enter the market, grant the company a wide economic moat, earning it pricing power and ROA of 16.3% (way above its cost of capital).

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Valuation

Despite 7% and 6% volume growth reported this quarter for the Jack Daniel’s and Finlandia vodka brands, drops regarding other products led the company’s overall volume to close at a mere 1% increase. Nevertheless, these quarterly results should be of little concern to investors, as Brown-Forman’s overall financial results are more than solid. While revenue for fiscal 2014 is expected to hit the $4 billion mark, in line with the annual 6.1% growth rate, EPS for this year is estimated at $2.98, sporting an average 10% increase over the next five years. The current 31.5% operating margins will also continue, at an attractive average of 33% looking forward. And although these future financial results could fall short if consumers taste changes, steering away from Tennessee Whiskey, I do not see this scenario as very likely.

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Moreover, the top line growth rate of 6.5% per year is bound to continue without further changes over the five year period, and the same goes for the current 36.3% returns on equity. The firm’s disciplined capital allocation strategies should also continue to generate excess returns on invested capital in the long term future. However, investors may find that the stock’s trading price of 29.4x trailing earnings is supporting a high 36% price premium relative to the industry average. This is mainly a consequence of Suntory’s BEAM acquisition, so I would recommend buyers to hold off until the price settles back down to 2012’s price (20.23x).

Dislcosure: Patricio Kehoe holds no position in any stocks mentioned.

About the author:

Patricio Kehoe
A fundamental analyst at Lone Tree Analytics

Rating: 4.5/5 (2 votes)

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