Fortune Brands: Calculating the Value Investment

May.13.10 | About: Beam, Inc. (BEAM)

Click to enlargeFortune Brands, Inc. (FO) is a holding company with operating companies engaged in the manufacture, production and sale of distilled spirits, home and security products, and golf products. Fortune Brands operates in three segments: Spirits, Home & Security and Golf. In June 2009, the Company acquired the EFFEN vodka brand and related assets from the Sazerac Company, Inc. In June 2009, the Company sold the Old Taylor whiskey brand and assets to Sazerac Company, Inc.

  • Last Price: $50.10
  • 52 Week High: $55.68
  • 52 Week Low: $31.58

Does FO make for an intelligent investment or intelligent speculation today?

Starting with a base estimate of annual Free Cash Flow at a value of approximately $700,000,000 and the number of shares outstanding at 152,320,000 shares; we used an assumed FCF annual growth of 5% for the first 10 years and assume zero growth from years 11 to 15. Review the Free Cash Flow record here.

The resulting estimated intrinsic value per share (discounted back to the present) is approximately $63.

  • Market Price = $50.1
  • Intrinsic Value = $63 (estimated)
  • Debt/Equity ratio = 0.85
  • Price To Value (P/V) ratio = 0.8 and the estimated bargain = 20%

Before we make a purchase, we must decide (filter #1) if FO is a high quality business with good economics. Does FO have (filter #2) enduring competitive advantages, and does FO have (filter #3) honest and able management.

  • Current price/earnings ratio = 24.8
  • Current return on capital = 3.02
  • Using a debt to equity ratio of 0.85, FO shows a 5-year average return on equity = 11.1

Some industries have higher ROE because they require no assets, such as consulting firms. Other industries require large infrastructure builds before they generate a penny of profit, such as oil refiners. Generally, capital-intensive businesses have higher barriers to entry, which limit competition. But high-ROE firms with small asset bases have lower barriers to entry. Thus, such firms face more business risk because competitors can replicate their success without having to obtain much outside funding.

Growth benefits investors only when the business in point can invest at incremental returns that are enticing; only when each dollar used to finance the growth creates over a dollar of long-term market value. In the case of a low-return business requiring incremental funds, growth hurts the investor. The wonderful companies sustain a competitive advantage, produce free cash flow, and use debt wisely.

Does FO make for an intelligent investment or speculation today? Time is said to be the friend of the wonderful company and the enemy of the mediocre one. Before making an investment decision, seek understanding about the company, its products, and its sustainable competitive advantages over competitors. Next, look for able and trustworthy managers who are focused more on value than just growth. Finally ask: Is there a bargain relative to its intrinsic value per share today?

Great investment opportunities come around when excellent companies are surrounded by unusual circumstances that cause the stock to be misappraised. In terms of opportunity cost, is FO the best place to invest our money today?

Time Forward Projection:

How will FO compete going forward? Keep in mind that a financial report like this is a reflection of the past and present. It may be used to project a future, but it may not account for factors yet unseen. Therefore, pay attention to competitive and market factors that may affect changes in profitability.

In summary, using a debt to equity ratio of 0.85, FO shows a 5-year average return on equity = 11.1 . Based on a holding and compounding period of 10 years, and a purchase price bargain of 20%, and a relative FCF growth of 5%, then the estimated effective annual yield on this investment may be greater than 7.3 %.

Disclosure: No positions