Brown-Forman Corp. (BF.A, Financial) (BF.B, Financial), the maker of Jack Daniel’s Tennessee Whiskey and Woodford Reserve, has a strong brand that could lead to a worthwhile investment. Do the fundamentals of this bourbon maker stack up, though?Â
Elevated spirits
Over the last 10 years, the median return on equity (ROE) and return on invested capital (ROIC) for Brown-Forman has landed at 30.45% and 21.68% respectively. Competitors Diageo PLC (DGE, Financial) and Constellation Brands Inc. (STZ, Financial), on the other hand, have turned in ROIC’s of 16.37% and 9.18% over the same period.
Importantly, Brown-Forman has delivered consistent returns: in the early part of the last decade, they ranged from 24% to 26% and have recently drifted to elevated ranges. This consistency lends itself to predictability in valuation and indicates the presence of a defensible moat.
Shifting to earnings, we find a steady upward march in earnings per share with a five- and 10-year growth rate of 7.58% and 7.42%. Comparatively, earnings for the S&P 500 have grown around 2.2% over the last 10 years.
Brown-Forman 10-Year EPS
| Ă‚ | 2008 | 2009 | 2010 | 2011 | 2012 | 2013 | 2014 | 2015 | 2016 | 2017 |
| Earnings per share ($) | 0.95 | 0.96 | 1.01 | 1.3 | 1.19 | 1.38 | 1.53 | 1.6 | 2.61 | 1.71 |
Brown-Forman margins stand securely lodged in double digits with a 10-year median operating margin of 32% and a median net margin of 21.29%. In comparison, the historic median ROIC for U.S. companies lands around 10%.Ă‚ Strong margins indicate the company has pricing power, cost control and a moat.
Other numbers of note
Total interest coverage for Brown-Forman is 16.81 times – 10 and above is considered good -- and the company could retire all of its $1.689 billion of long-term debt in just under three years. In other words, Brown-Forman is not going bankrupt anytime soon.
Capital spending for 2017 was $29 per share and represented 4% of sales. On the other hand, the median net capital spending to sales for all U.S. sectors in 2017 is 5.26%. Capital expenses serve as anchors to companies that have to keep spending to “keep the machines running,” whereas low capital companies can create greater shareholder value through higher return investments.
A moat of bourbon
Brown-Forman’s chief line of bourbon, Jack Daniel’s Tennessee Whiskey, represented 11% of total whiskey sold in the U.S. in 2017 and enjoys a strong, name-brand recognition with customers. This in turn creates a “Hershey bar” effect in which customers will walk out of a store and go across the street if they cannot find their favorite chocolate bar (bourbon). This leads to demand from vendors.
In addition, Brown-Forman has successfully branched out its main bourbon into brand extensions Tennessee Honey and Tennessee Fire in recent years. These extensions provide a runway for growth and the Brown-Forman castle is further fortified by significant barriers to entry: it takes two years to age bourbon and the manufacturing process is tough to replicate.
Valuation
A quick assessment of value can be found in the Peter Lynch earnings growth formula: add the projected long-term earnings growth rate to the dividend yield and divide by the price-earnings (P/E) ratio. For Brown-Forman, the consensus growth rate lands around 8.5% and the dividend yield is 1.51%. By adding these together and dividing by its P/E of 27.7, we find 0.36. According to Lynch, a 2 or better is great, 1.5 is good and less than 1 is poor. It is safe to say 0.36 is terrible.
The Lynch fair value earnings line of 15 times earnings shows a fair value of $22 versus a current price of approximately $48. In theory, this earnings line will pull the price along: if it is above the line, it will eventually be pulled down.
Finally, we look at the all-important discounted cash flow model to find a consensus on valuation. Using owner earnings of $612 million, earnings growth rates ranging from 5.95% to 9.35%, an assumed second stage rate of 5%, current shares outstanding of 390 million and a discount rate of 7.45% (the 30-year treasury bond rate plus Aswath Damodaran’s risk premium), I find a fair value of $81.47 per share for a long-term return of approximately 9%. With a share price of $48, this is not shabby but also not great.
The bottom line
Brown-Forman is a great company with solid fundamentals and a strong moat. It has strong returns on equity and invested capital, predicable earnings that have been growing at a good clip, double-digit margins, a strong balance sheet and a durable moat built on brand loyalty and barriers to entry. The problem lies in the price. If it ever tips to the bottom of the barrel, it would be a great opportunity to take a large sip of this bourbon company.
Disclosure: The author does not own shares in any of the companies mentioned.
