Brown-Forman: Is Bourbon a Buy?

Keeping with the booze, burgers and butts allocation I recommended in my Ambev (ABV) analysis, today I’m taking a look at Kentucky’s Brown-Forman (NYSE:BF.B), a premium spirits and wine manufacturer with a portfolio of 30 brands sold in 135 countries. International sales account for half of the company’s revenues. Major competitors include UK-based Diageo (NYSE:DEO) and Constellation Brands (NYSE:STZ).
Brand Recognition
The company’s strongest brand, Jack Daniels Tennessee Whiskey, accounted for 45% of volume in fiscal 2010. Other brands include Finlandia vodka, Southern Comfort, Fetzer wines and Korbel champagne. Collectively these ubiquitous labels are a presence on the shelves of liquor stores, bars and nightclubs everywhere. Jack Daniels is often linked to its most popular chaser, Coca-Cola (NYSE:KO), arguably the strongest brand name in the world.
Earnings Trend
A strong and rising earnings trend often indicates a business benefiting from a competitive durable advantage and profit-minded management.
Brown-Forman Earnings per Share
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
1.33
1.45
1.69
2.02
2.08
2.51
2.85
2.87
3.02
3.90
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Brown-Forman’s earnings have been remarkably consistent with a strong upward bias. People tend to drink in good times and in bad, and while the EPS rate of change slowed between 2008 and 2009, demand for the company’s products remained solid during the financial crisis.
Debt
Great businesses typically generate strong cash flows and require little debt financing. I like to see long-term debt less than three times current net earnings. With long-term debt of 504 million and trailing 12-month net income of 572 million, Brown-Forman could easily cover its obligations within one year.
Return on Equity
Companies that consistently deliver high returns on equity create the true wealth for shareholders. Average businesses typically offer a 12% return on equity while great businesses return over 15%.
Brown-Forman Return on Equity
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
18.25
22.78
26.81
25.72
22.28
24.81
26.68
24.57
24.20
28.93
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Brown-Forman’s 10-year average ROE is an enviable 24.5%.
Retained Earnings
I want to own companies that are free to reinvest retained earnings at high rates of return. What I don’t want to see is high research and development costs or capital expenditures in the form of plant and equipment replacement. In Brown-Forman’s case, investments in property, plant and equipment were only 7% of net income over the trailing 12 months. In previous years, these investments reached as high as 23% of net income but are easily manageable thanks to the simple cost structure elsewhere (i.e. mild SG&A, no R&D). Year after year, free cash flow is positive.
Getting to a Verdict
Brown-Forman’s strong fundamentals indicate a business with a durable competitive advantage. Making the investment case even more compelling is the fact that the company has increased its dividend annually for the last 27 years. There is a difference, however, between a great company and a great undervalued company. In the second part of this analysis, we’ll look at Brown-Forman’s valuation and decide on a desirable buy price.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in BF.B over the next 72 hours.