Brown-Forman: Great Franchise but Time to Hold or Sell Out

Includes: BF.A, BF.B
by: Brian Polino

Brown-Forman Corporation (NYSE: BF.A, BF.B), the renowned maker of Jack Daniels and Southern Comfort, is a great company with a strong franchise adept with economies of scale and an international growth focus. The company is well-diversified and truly reaps the benefits of its wide variety product portfolio. In fact, I always keep Brown-Forman on my default investment list as I like to buy the stock from time to time when it becomes clearly undervalued. However, at the current time, I believe the Brown-Forman Class A shares are fairly valued at $61.12.

Before continuing with the analysis, I have a word of advice for all investors concerning liquidity. This time I should have bought the Brown-Forman Class B shares as they are part of the S&P500 and very liquid as compared to the Class A voting shares, which hardly trade on a day-to-day basis. I found myself taking quite awhile buying and selling my position of Class A shares due to illiquidity constraints.

While this maybe ok for a good company, such as Brown-Forman, trying to unload positions in distressed and illiquid stocks may prove disastrous if panic conditions arise.

In terms of operating results, Brown-Forman offers strong business fundamentals. With profit margins of 14% and a return on equity of 24%, the company is a leader in its industry returning 10% a year to investors over the past decade. However, with a P/B ratio of 4.8, the company is perhaps fairly or a little overvalued at the current price of $61.12. With FCF of $454M and factoring in strong growth, I give Brown-Forman a fair value of $50 to $55 assuming all growth and operations go well for the next 10-15 years. However, the current price offers no margin of safety, and it may be best to sell now then buyback later if prices drop closer to $50.

Here is my stock price breakdown:

Earnings Power Value with no growth: $33/share

+ Growth Value: $20/share

= Intrinsic Value: $53/share

vs. current market price of $61.12

Margin of Safety = negative $8.12

*For my calculations, I used both 10-year multi-stage FCF growth and no-growth perpetuity models to compute the growth and no-growth valuation scenarios. I used a discount rate of 10%.

On the other hand, if you were to hold onto your shares at $61.12 for the next 10-15 years, there is a good chance Brown-Forman would provide you a satisfactory return in the long run. It is just a little too expensive right now without adequate margin of safety to guarantee returns and avoid the possibility of loss.

Disclosure: No positions