In part 7 of the 54-part Dividend Aristocrats In Focus series, I will look into the oprerations, competitive advantage, future growth prospects, and valuation of Brown-Forman (BF.B, Financial). Brown-Forman manufactures and sells alcoholic beverages globally. The business’ flagship brand is Jack Daniels. They also own Sonoma wines, Korbel Champagne, Chambord, Tuaca, Southern Comfort, El Jimador and Finlandia Vodka. Brown-Forman has increased its dividend payments for 30 consecutive years. Brown-Forman has grown shareholder value on the strength of its high quality spirits brands.
Competitive advantage
Brown-Forman’s competitive advantage comes from its respected brands. The company’s flagship brand is Jack Daniel’s. Jack Daniel’s is to Brown-Forman what Coca-Cola is to The Coca-Cola Company (KO, Financial). American whiskey is in style across the globe. This wasn’t always the case. From the mid-1970s up until the mid-2000s, global whiskey volume was in decline.
Source: Brown-Forman Back to School Presentation
Fourth generation Brown family (of Brown-Forman) member and current Chairman of the board at Brown-Forman Garvin Brown IV makes the case that American whiskey is back in style around the world because of Brown-Forman and the Jack Daniel’s Brand in the company’s 2014 Annual Report:
I would like to suggest, however, that this category trend and Brown-Forman’s good fortune are not a coincidence. In fact, were it not for Brown-Forman’s focus on American whiskey, and in particular, its home states of Kentucky and Tennessee, I have no doubt that the industry would not be seeing this resurgence. It just seems difficult to imagine that there would be a global demand for American whiskey had Brown-Forman not painstakingly grown the Jack Daniel’s family of brands from less than 5 million cases to almost 14 million cases, on a drink-equivalent basis, over the past 20 years.
It is rare to see a brand shape consumer demand and an entire industry quite the way Jack Daniel’s has transformed American whiskey. The company’s other brands also generate high returns on invested capital and strong operating margins. High ROIC and high operating margins show that the company is able to charge a premium price for its products that consumers are more than happy to pay.
Source: Brown-Forman 2014 Annual Stockholders Meeting Presentation
Growth potential
Brown-Forman’s growth over the decades has been relatively constant. The company has managed to compound earnings per share at over 9% a year for 35 years. The company has grown earnings per share at over 9% a year in the last 5 years as well; Brown-Forman shows no signs of slowing growth.
Source: Brown-Forman 2014 Annual Report
The company’s future growth will come from rising demand for premium spirits in both developed and developing economies. Developed markets have grown premium spirit retail sales at 7% a year since 2003. This strong growth comes despite the Great Recession of 2007 to 2009 and sluggish GDP growth in the developed world over the same time period.
The developing world is seeing even faster premium spirit retail growth. Since 2003, premium spirit retail sales have grown at 14% a year in developing markets. Double-digit growth in the developing world presents a huge opportunity for Brown-Forman going forward. The company currently generates the bulk of its revenue in the developed world, but is showing positive signs in developing economies. The company’s percentage of total revenue by developing country is listed below:
- Mexico: 6% of total revenue, -5% sales growth in fiscal 2014
- Poland: 4% of total revenue, 5% sales growth in fiscal 2014
- Russia: 2% of total revenue, 19% sales growth in fiscal 2014
- Turkey: 1% of total revenue, 24% sales growth in fiscal 2014
In addition, the company generated 8% of its revenue from “other” markets (other is category in annual report). These markets include Brazil, Japan, China, Southeast Asia and Africa. Obviously, Japan is not a developing market but most of the other constituents of the “other” category are. The “other” country category grew revenue 12% in fiscal 2014 as compared to fiscal 2013.
Brown-Forman’s developing market growth was very favorable in Turkey and Russia for fiscal 2014. While individual breakdowns are not reported, Asia, Brazil and Africa appear to be growing revenue in double digits as well. The company saw negative growth in Mexico due to excessive inventories held by wholesalers to start the year and strong competition in the Mexican tequila market exacerbated by a poor economic environment in Mexico. In 2015, Mexico should return to growth for Brown-Forman. The rest of the developing world will very likely continue to provide strong growth for Brown-Forman as consumers in these markets continue to demand ever greater amounts of premium spirits.
Dividend analysis
Brown-Forman currently has a dividend yield of about 1.5% and pays out about 36% of its earnings as dividends. The company has raised its dividend payments by over 50% in the last 5 years. Shareholders of Brown-Forman will likely see dividend growth of around 8% to 10% a year from organic growth. If the company chooses, it can grow dividends faster than overall company growth safely for several years due to its fairly low payout ratio.
The company paid a special cash dividend of $4.00 per share in 2012. If the company builds up excess cash it may reward shareholders again in the future with a special dividend. The company currently holds about $2.10 per share in cash, so a large special dividend is unlikely for the next few years.
Recession performance
Alcohol continues to be in demand during recessions. Brown-Forman’s sales dipped very slightly from their pre-recession high of $11.42 per share in 2007 to a low of $11.02 per share in 2008. The company’s earnings per share increased each year of the recession of 2007 to 2009. Brown-Forman’s underlying business has proven it can not only withstand recessions, but grow earnings no matter the economic environment. The company’s stock price had a maximum drawdown of about 50% during the recession of 2007 to 2009. Long-term investors in the company’s stocks should take comfort in knowing that the underlying value of the business does not suffer during recessions. The stock price, however, does fluctuate along with the overall market.
Valuation
Brown-Forman is a fantastic business. Unfortunately, it appears to be substantially overvalued. As stated previously in this article, the company’s long-term earnings per share growth rate is about 9%. The company has a P/E ratio of 29. A company with a 9% earnings per share growth rate should not trade at a P/E ratio of nearly 30, even if it is a high-quality business with limited downside risk. The company’s fair value is likely closer to a P/E ratio of 18 to 20, rather than 30. The company’s stock traded for most of the period from 2008 to 2011. Brown-Forman is currently trading near its 5 year high P/E ratio and is very likely overvalued.
Final thoughts
Brown-Forman is one of the lowest risk businesses around. It operates in the very slow-changing spirits industry. The company can charge a premium price for its products thanks to excellent branding. Brown-Forman also has a long growth runway ahead in the developing world. The company is virtually recession resistant and has proven it can grow earnings per share through economic downturns. Finally, Brown-Forman management is very shareholder friendly and has paid increasing dividends for 3 decades. The company paid a large special dividend to shareholders in 2012, and management has been excellent stewards of the company’s capital, focusing it on growing their high quality brands.
Brown-Forman stock has risks that the underlying business does not. The company is very likely overvalued. Purchasing an overvalued business exposes the investor to risk that the stock will revert to its historical P/E multiple, causing a loss for investors along the way. Brown-Forman is an excellent business, and will be a great buy when the P/E ratio falls to a more reasonable level. Until then, I believe there are better Dividend Aristocrat investment options available.
