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 (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.
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 (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.
SGA : Gross Profit
R&D Expense : Gross Profit
Depreciation Expense : Gross Profit
Interest : Gross Profit
EPS, basic ($USD/share)
The income sheet of Brown-Forman suggests it has a competitive advantage in the marketplace. Strong points of the income sheet include the gross margin, which averages over 40% for the last 10 years, a low depreciation expense, and no R&D or interest expenses. In addition, earnings per share have grown consistently over the last 10 years with an average annualized growth rate of 10.4%. However, two metrics gave me momentary pause.
The first was the net margin; with a 10-year average of 14.4%, it is below the 20+% I usually see for companies with very strong competitive advantages. I still believe there is a competitive advantage for the company because the ratio has consistently been above 10% each year for the past decade, but think that it likely is not as strong as say Coke-Cola (KO).
The second metric to cause some pause was the ratio of SGA expense to gross profit. The 10-year average ratio of SGA expense to gross profit was 54.7%, almost 5% above my ideal criteria of 50%. In this instance, I think the company still has a competitive advantage because, 1) the depreciation expense is low and the company has no R&D or interest expense and 2) it still less than 65% of gross profit.
Cash & Short Term Investments ($M)
Liabilities : Stockholder Equity + Treasury Stock
Retained Earnings ($B)
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
Capital Expenditures : Gross Profit
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.
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 (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?