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After sharing my method for identifying companies that have a competitive advantage last week, it got me thinking about what other companies could be enjoying a competitive advantage. While getting a drink with a friend this weekend, it made me think that alcohol brands have huge brand value that could translate into a competitive advantage.

While I intend to do a deep dive of the industry as a whole in the next few days, my quick research revealed that Brown-Forman Corp (NYSE:BF.B) meets the criteria of my competitive advantage screener. Today, I want to share with you my analysis of the last 10 years of data taken from ycharts.com.

Company Background

First established back in the 1870s, Brown-Forman Corp. is the third largest distiller and importer of alcoholic beverages by market cap, behind mega brand competitors Diageo (NYSE:DEO) and Pernod Ricard (OTCPK:PDRDY). Many of you are probably familiar with Brown-Forman's flagship brand, Jack Daniel's Tennessee Whiskey, but the company's portfolio of brands also includes many big names like Canadian Mist, Southern Comfort, Chambord, Don Eduardo, and Korbel.

Income Sheet

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

Gross Margin

49.7%

50.6%

49.9%

49.4%

51.6%

52.8%

54.2%

52.7%

51.2%

49.7%

SGA : Gross Profit

55.9%

45.7%

56.1%

56.5%

59.2%

57.9%

53.4%

61.3%

63.6%

68.1%

R&D Expense : Gross Profit

0.0%

0.0%

0.0%

0.0%

0.0%

0.0%

0.0%

0.0%

0.0%

0.0%

Depreciation Expense : Gross Profit

0.2%

0.3%

0.3%

0.3%

0.3%

0.1%

0.0%

0.0%

0.0%

0.0%

Interest : Gross Profit

0.0%

0.0%

0.0%

0.0%

0.0%

0.0%

0.0%

0.0%

0.0%

0.0%

Net Margin

14.2%

16.8%

13.9%

13.6%

13.4%

13.9%

13.3%

14.0%

12.6%

10.2%

EPS, basic ($USD/share)

2.393

2.613

2.02

1.92

1.913

1.693

1.397

1.35

1.116

0.9547

The income sheet of Brown-Forman suggests it has a competitive advantage in the marketplace. Strong points of the income sheet include the gross margin, which averages over 40% for the last 10 years, a low depreciation expense, and no R&D or interest expenses. In addition, earnings per share have grown consistently over the last 10 years with an average annualized growth rate of 10.4%. However, two metrics gave me momentary pause.

The first was the net margin; with a 10-year average of 14.4%, it is below the 20+% I usually see for companies with very strong competitive advantages. I still believe there is a competitive advantage for the company because the ratio has consistently been above 10% each year for the past decade, but think that it likely is not as strong as say Coke-Cola (NYSE:KO).

The second metric to cause some pause was the ratio of SGA expense to gross profit. The 10-year average ratio of SGA expense to gross profit was 54.7%, almost 5% above my ideal criteria of 50%. In this instance, I think the company still has a competitive advantage because, 1) the depreciation expense is low and the company has no R&D or interest expense and 2) it still less than 65% of gross profit.

Balance Sheet

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

Cash & Short Term Investments ($M)

338

567

232

340

119

369

635

295

680

72

Liabilities : Stockholder Equity + Treasury Stock

49.0%

62.2%

62.8%

77.3%

82.8%

118.1%

68.9%

91.9%

102.4%

99.4%

Retained Earnings ($B)

3.031

2.71

2.464

2.189

1.931

1.649

1.607

1.415

1.218

1.506

Brown-Forman's balance sheet is comparable in strength to its income statement. I like that retained earnings has grown consistently over the last 10 years with an average annualized growth rate of 8.1% and thereby exceeding my 7% minimum. Cash has also been accumulating, with an average annualized growth rate of 18.7%.

On the other hand, the ratio of liabilities to stockholder equity plus treasury is not ideal. From 2003 to 2008, it was consistently above the 0.8 I recommend for manufacturing stocks. Since 2008, the ratio has steadily declined. With the ratio's 10-year average yielding 0.67 and the trend being in the right direction, I feel this metric indicates Brown-Forman has competitive advantage.

Statement of Cash Flows

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

Capital Expenditures : Gross Profit

3.2%

1.6%

2.0%

3.1%

2.1%

3.0%

3.4%

3.8%

3.8%

10.0%

The statement of cash flows for Brown-Forman was extremely positive. The median over the past decade is an astounding 3.2% and well below the 25% ratio typical of other companies displaying a competitive advantage.

Conclusion

After analyzing the financial statements of Brown-Forman for the last decade, I would conclude that the company has a competitive advantage. While the analysis did not yield values as strong as Qualcomm (NASDAQ:QCOM), I think Brown-Forman has less risk from a favorable long term economic perspective since its advantage is likely coming from its strong brands rather than innovation and patents.

From an investment perspective, I have put this company on the wait list. I have some concern about the most recent year's decline in EPS and the current market evaluation (I guess other people realized it had a competitive advantage before I did).

I feel shares of BF.B selling at $63 per share are overpriced. I came to this conclusion by projecting the past decades average annualized growth rate of 10.4% into the future. This yielded an EPS of 5.79 in 2023. Then, using a conservative P/E multiple of 15.5, which represents the median of the lowest P/E multiple of each year for the last decade, I calculated that shares would be worth around $90 per share. If purchased at $63 dollars a share, that would yield a return of just 4% excluding dividends; which is far below my margin of safety.

While waiting for the market price to drop (or earnings to grow significantly) I intend to review competition and better understand the business so I am prepared to strike if the opportunity comes.

P.S. - do any readers know a better source for 10+ years of financial data?

Source: Jack Daniel's Is Creating A Competitive Advantage For Brown-Forman