Introduction
Lately I’ve been investigating high quality companies so that I can be prepared during the next market selloff. Union Pacific was the first company I analyzed in this quest. Now in this post, I am analyzing Brown-Forman (I may have sampled some of their products for “research”). What I’m trying to understand is the business model, the company’s products, analyze the financials, and try to do a rough valuation. The goal is to determine if I should put Brown-Forman on my watchlist, or pass on it for a different idea.
Business Description
Brown-Forman (BF) is one of the largest American spirits companies. BF owns a portfolio of brands, but is most known for their Jack Daniels whiskey. The company is family controlled and has two share classes. The family controls most of BF-A which has all the voting power, while BF-B does not have any voting power. Brown-Forman is headquartered in Louisville, Kentucky. The company was founded in 1870, and went public in 1933, so it’s been around for a while.
For a quick history lesson, Brown-Forman’s first product was Old Forester whiskey. Their claim to fame is that Old Forester was the first whiskey to be sold in a sealed glass bottle. Early on, the company bought whiskey from other distilleries and blended them for sale. Eventually, BF purchased their own distillery plant. In the 1950’s, Brown-Forman purchased the Jack Daniels brand, which is now a huge brand. I find it interesting that Old Forester was BF’s original brand, but now Jack Daniel’s is the core of the company.
Product Line
Brown-Forman has many brands spread across the different types of liquor. The following is just the highlights of BF’s product line. Whiskey forms the core of the company, with Jack Daniels. There is also Old Forester, the premium Woodford Reserve line, and the low-end Early Times. Brown-Forman also owns the well known Canandian Mist brand, but they are in the process of selling it. Fairly recently, BF has acquired several scotch distilleries that includes the BenRiach, GlenDronach, and Glenglassaugh brands.
The company owns a California winery, Sonoma-Cutrer, as well as Korbel sparkling wine. In the vodka department BF has the Finlandia brand. As for tequila, they have the el Jimador and Herradura brands.
The Jack Daniel’s “Ready to Drink” products are like a cocktail in a can. These are geared towards younger people to introduce the Jack Daniel’s brand.
The past few years have seen different Jack Daniel’s flavors such as honey or apple being released that have boosted growth. Then you have all the various whiskey age/barrell variety combinations such as Woodford Reserve Double Oak.
Summary Statistics
The table shows various summary statistics of Brown-Forman. The company is about $30B in size, which makes it a mid-cap these days? The valuation ratios indicate that BF is pretty expensive, which we’ll get to later. Right now, the price of Brown-Forman is around $70 a share, but during the March 2020 selloff it was near $50. Return on equity is at 37%, suggesting this is a quality company. The debt levels are fairly reasonable with a D/E around 1 and Debt/EBITDA around 2. Some might say Brown-Forman could/should increase their debt load a bit since they are a quality company and interest rates are low. However I tend to prefer less debt. I’m estimating earnings growth around 4% based on historical growth. I’m not making any fancy projections, but slightly above inflation seems reasonable.
| Market Capitalization | $32B |
| Enterprise Value | $34B |
| P/E | 36 |
| EV/EBIT | 33 |
| 52 Week Price | $52-82 |
| ROE | 37% |
| D/E | 1.07 |
| Debt/EBITDA | 1.98 |
| Earnings Growth | ~4% |
Financials
Here I summarize Brown-Forman’s financials based on their income statement, balance sheet, and cash flow statement. I believe that taking a look at a company’s financials is key before making an investment.
Income Statement
In 2020 Brown-Forman produced revenue of $3.36 billion. It should be noted that their fiscal year ends in April, so these financials are only showing the beginning of the pandemic. Looking at the profit margins, we see a gross margin at 61%, operating margin of 31%, and a net margin of 27%. These are definitely attractive margins, which further supports that BF is a high quality company.
The income statement is summarized in the pie chart below where the entire pie is Brown-Forman’s revenue. It can be seen that the cost of goods sold and SG&A are the main expenses. Income tax, interest, and depreciation make up a pretty small slice of expenses. In summary, the income statement looks pretty straightforward with a healthy net income.
Assets
Next, let’s take a look at Brown-Forman’s balance sheet. The assets are broken down in the chart below (some smaller line items are omitted for clarity). The first thing to note is the $1.1B in cash, making up about 17% of their assets. Inventory is recorded at $1.72B. It’s a bit funny thinking about $1.7 billion in liquor sitting around. The rest of the assets appear reasonable with property and plant taking up a decent chunk. The amount of intangibles is expected from a company with strong brands. Finally, there is some goodwill, reflecting the acquisitions BF has made. The high cash balance would seem to support a strong balance sheet, and the rest of the assets are as you would expect.
Liabilities
For the liabilities side of Brown-Forman’s balance sheet, the main line item is the $2.3B in long term debt. This amount of debt is fine since there is $1.1B in cash available that could wipe out most of it. Short term debt is at $312M, which most of it was raised in 2020. The other thing to note from Brown-Forman’s liabilities is the pension liability, which most companies these days don’t provide a pension. Like the assets, there is nothing out of the ordinary or any red flags with BF’s liabilities.
Cash Flow
The table belows shows a simplified view of Brown-Forman’s cash flow statement. Looking at 2019 and 2020, BF’s operating cash flow is between $700-800M. In both years, capex is about the same being around $120M. It would be useful to find out if this is maintenance capex, or used to build new PP&E that could provide growth. There were no acquisitions in 2019, but a small one in 2020.
Cash from financing first consists of raising $178M of short term debt in 2020. Buybacks were performed in 2019 to the tune of $207M, but none were during 2020. Brown-Forman seems to do sporadic buybacks so I’m not sure if the lack of buybacks in 2020 is COVID related, or just coincidence. Finally, in both years the dividend is a bit north of $300, with BF maintaining their record of increasing their dividend annually. Brown-Forman’s cash flow statement is pretty straightforward. The cash flow statement can provide good insights on the company’s capital allocation, so the simpler the better.
| ($M) | 2020 | 2019 |
| Cash From Operations | 724 | 800 |
| Capex | (113) | (119) |
| Acquisition | (22) | 0 |
| Cash From Investing | (141) | (119) |
| Short Term Debt | 178 | 71 |
| Buyback | (1) | (207) |
| Dividend | (325) | (310) |
| Cash From Financing | (191) | (599) |
| Change in Cash | 368 | 68 |
Capital Allocation
A company’s capital allocation strategy is key to having strong long term performance. Here I will try to summarize Brown-Forman’s capital allocation based on my light research. In 2016, BF sold the popular Southern Comfort brand. The company is currently in the process of selling Canadian Mist. I find it interesting that BF is selling these well known brands, but presumably they are selling them for an attractive price. On the other hand, Brown-Forman has been acquiring assets such as the scotch brands, and the recent acquisition of Ford’s gin. It appears BF has a thought out strategy to reorient their portfolio of brands.
The other key area of capital allocation is return profits back to shareholders. As mentioned above, BF repurchased $207M shares in 2019. Oddly, BF did not repurchase any shares in 2018, but did buyback $571M in 2017. The large 2017 repurchase may be due to the sale of Southern Comfort in 2016. I’m not sure if Brown-Forman is only buying back their share at what they think are attractive prices, or if there is another reason for these sporadic purchases.
On the dividend front, Brown-Forman is a dividend aristocrat, consistently paying a dividend for 76 years, and raising the dividend for 37 straight years. While sometimes it can be suboptimal to pay a dividend, Brown-Forman is a high quality, low growing company, so it seems reasonable. The dividend payout ratio is 37%, which leaves the company with plenty of retained earnings to reinvest.
Brown-Forman Valuation
Oftentimes when I value a company, I use a basic discounted cash flow analysis to get a rough fair value. Looking at Brown-Forman’s free cash flow the past few years, a reasonable figure to use in the DCF is about $700M. For the growth rate, I’m using 4% based on BF’s past growth. This growth rate is slightly above inflation, which seems appropriate. Typically, I would use a 10% discount rate, but doing so for Brown-Forman would produce a much lower fair value than what the stock is trading at. In this case, I reverse engineered what discount rate the market is implying. The discount rate I came up with is 4.5%. This is a very low discount rate. However BF is a quality stock, so it makes sense that the market would be discounting it slightly above the risk free rate.
Putting all these variables together, we get a fair value around $65 which is near what the stock is trading at today. The 4.5% discount rate implies that if you bought it today, you would expect to receive a 4.5% return by holding for the long term. This rate of return is far lower than I would be trying to achieve.
But you have to consider that I’m competing against pension funds, endowments, and other institutional investors that are willing to accept lower returns. These funds need a replacement for bonds since interest rates are so low. Therefore, they look at quality companies as an alternative, bidding up the valuation. A quality company that is slightly growing, paying a little dividend, and doing some share buybacks is a lot more attractive than a bond yielding 2%. So all that to say, Brown-Forman is not currently attractive for me, but I understand why it is at this valuation.
Buying the Dip
While Brown-Forman does not provide the most attractive return at its current price, occasionally the stock sells off like March 2020. During that period, BF dropped to about $50 a share. If you were lucky enough to buy it at this low price, you would experience about a 40% gain as the stock reverted back to $70. A 40% gain, then compounding at 4.5% into the future, should produce a decent internal rate of return if held for 5 years or so. Obviously this only works if the stock reverts back to its prior valuation. My conclusion is that if I were to buy some Brown-Forman, I would wait until there was a panic and Mr. Market could offer me a once in ~7 year deal.
Brown-Forman During Inflation
Another aspect I want to consider is how Brown-Forman would perform during an inflationary period. On one hand, BF’s multiple could compress if interest rates go from low to high(er). Since Brown-Forman is so richly valued because of low interest rates, if rates increased then investors would have to increase their discount rates. It would seem reasonable that the share price of BF would take a hit during this period.
On the other hand, Brown-Forman should be able to easily increase the price of its products during an inflationary period. While i need to do more research, I would think that people buying liquor are pretty price insensitive, especially when all brands would be raising prices with inflation. Another point is that BF does not have heavy capex needs. Companies that have to constantly overhaul their factories would be forced to pay ever increasing prices for equipment during inflation.
Based on this, it is possible that Brown-Forman’s business would do ok during an inflationary environment, but the stock price could languish. Perhaps if this scenario played out, it would be a good opportunity to dollar cost average into the company.
Business Risks
While Brown-Forman is a quality company, there are still a few risks worth further researching. One unique problem with liquor is that some of the products need to be aged for 5+ years. This means you have to predict what demand will be like far into the future, which is hard. Over the past 10 years, whiskey has been trendy. If the trend passes, then demand could be much lower in the future.
The Jack Daniel’s brand is vital to Brown-Forman. If somehow, the Jack Daniel’s brand fell from grace, then BF would be in some hard times.
In 2018 the EU enacted tariffs against Jack Daniel’s in retaliation to the Trump administration’s tariffs on steel. I guess they targeted Jack Daniel’s since it is a quintessential American brand. Apparently the EU tariffs are supposed to double in June 2021 if the trade relations do not approve.
Government regulation could negatively impact Brown-Forman. Alcohol has tricky advertising regulations across different countries. Governments could also impose gaudier warnings labels, which could affect sales.
Finally, I have anecdotally heard that cannabis could take market share from liquor companies. I don’t know anything about the cannabis industry, but this threat seems somewhat reasonable. On the flip side, I guess nothing stops Brown-Forman from making a cannabis infused tequila or something.
Conclusion
After analyzing Brown-Forman, I can definitely say that it is a quality company. I would love to own this business, but the valuation is an issue. The best hope to make the type of return that I seek is to wait for a market panic and hope that BF’s price reverts back to normal levels. Given this reality, I am curious if any of the other quality companies in my pipeline will prove to be more attractive than Brown-Forman.
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