A Look At Distillers: Brown-Forman, Constellation Brands And Diageo In The Global Context

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Includes: BF.B, DEO, DTLJF, DVDCY, LVMHF, PDRDY, REMYF, STZ, TBVPY
by: Dave Hickling

Summary

This is an overview of global distillery companies with more than $1 billion market cap, with an emphasis on U.S. stock market traded companies.

Brown Forman, Constellation Brands (not really a distiller) and Diageo are considered for investment.

There is a focus on income statements given differences in operating margins between companies.

Differences in marketing spending are impacting profitability.

Differences in growth and debt management are also discussed.

Introduction

I had never paid much attention to alcohol stocks, but after reading some popular press articles about the resurgence in the global whisky industry, I wondered if there were investment opportunities. It is apparent that alcohol companies are generally pretty profitable businesses and stock market returns have been pretty good in the last few years. For this article, I will focus on companies that are mainly in the distilling (spirits) business. In fact, most distilling companies also have beer and wine products, which is not surprising given distribution synergies. I will look at 6 different companies: three which trade on U.S. stock exchanges: Brown-Forman (NYSE:BF.B), Constellation Brands (NYSE:STZ) and Diageo (NYSE:DEO) and three that trade on European stock exchanges: Campari (OTCPK:DVDCY), Pernod Ricard (OTCPK:PDRDY) and Remy Cointreau (OTCPK:REMYF). I am not interested in buying the three European stocks but it is useful to see how the U.S. traded companies stack up against them.

It turns out that there are significant differences between the companies which impact their suitability as investments. There are pretty big differences in profitability which, it turns out, bear looking at in terms of marketing and labor efficiencies.

Distiller Company Comparisons

Here is a snapshot of the six public distilling companies and their main spirits brands.

Table 1. Public distiller company comparison. Market cap USD as of March 17, 2017.

Company

Ticker/Market

Country

Market Cap, $B

Notes

Brown-Forman

BF.B-N

U.S.

$18.2

Public but Brown family-controlled. Large basket of spirits. They have the #1 selling American type whisky - Jack Daniels. Also have Herradura and El Jimador tequilas and premium BenRiach and Glendronach single malt scotch whiskies.

Campari

CPR-MI

Italy

$6.2

Large basket of spirits, notably Wild Turkey bourbon whisky, Cabo Wabo tequila, Skyy vodka, Appleton Estate rum and Campari and Cinzano liqueurs

Constellation Brands

STZ-N

U.S.

$31.7

Mainly a beer and wine company with only 5% of revenue from spirits so it probably shouldn't be compared apples to apples with the distillers. Notable spirits brands are Black Velvet whisky and Svedka vodka. It is kept in this comparison since it is U.S. listed.

Diageo

DEO-N

U.K.

$74.0

Largest basket of spirits, including # 1 selling scotch whisky (Johnnie Walker), #1 selling vodka (Smirnoff) and #1 selling gin (Gordon's). Also have Crown Royal whisky, Lagavulin, J&B and Bell's scotch whiskies, Don Julio tequila, Captain Morgan rum and Baileys liqueur. Also own Guinness beer. Has significant stakes in LVMH and United Spirits (an Indian company).

Pernod Ricard

RI-PA

France

$30.1

A major player with a large basket of spirits including Jameson Irish whisky, Chivas Regal and Ballantines scotch whiskies, Beefeater gin and Martell cognac.

Remy Cointreau

RCO-PA

France

$4.6

A few key spirits brands including Mount Gay rum, Remy Martin brandy and Cointreau liqueur

There are other very significant publicly traded distillers but they are not included in the comparison since they are either regional or alcohol production is a small part of their business.

Table 2. Other public distiller companies not compared. Market cap USD as of March 17, 2017.

Company

Ticker/Market

Country

Market Cap, USD B

Notes

Distill Group

OTCPK:DTLJF

South Africa

$2.4

A diversified alcohol company with holdings in spirits, wine and beer. It mainly serves the African market. Brands include Three Ships and Scottish Leader whiskies.

LVMH Moet Hennessy

OTCPK:LVMHF

LVMH-MI

Italy

$106.3

A luxury goods company (Luis Vuitton) with alcohol providing only 13% of revenue, it is 34% owned by Diageo. Notable spirits brands are Glenmorangie Scotch whisky, #1 selling Hennessy brandy and Grand Marnier liqueur.

Thai Beverage

OTCPK:TBVPY

Y92-SI

Thailand

$16.6

Operates mostly in Asia. Some notable international brands are Old Puteney whisky and Speyburn scotch whisky, Meridian Brandy and Coldstream gin.

The above companies are all public. There are also a number of important private distilling companies:

Bacardi. Notable brands are: Bacardi rum, Bombay gin, Cazadores tequila, Grey Goose vodka, Dewars whisky and Benedictine liqueur.

Beam Suntory. A huge whisky company which is part of the Japan-based Suntory Holdings - a private company. Suntory does hold STBFY, a publicly traded non-alcoholic beverage and food division. Notable brands are: Jim Beam, Canadian Club and Yamazaki whiskies, Laphroaig and Bowmore single malt scotch whiskies, Sauza and Hornitos tequila, Pinnacle vodka, Gilbey's gin and Courvoisier brandy.

William Grant & Sons. Notable brands are: Glenfiddich, Grant's and Balvenie scotch whiskies, Sailor Jerry rum and Drambuie liqueur.

Edrington. Notable brands are: The Famous Grouse, The Macallan, Cutty Sark and Highland scotch whiskies.

Proximo Spirits. Notable brand is #1 selling Jose Cuervo tequila

Sazerac. A U.S. company with considerable American type whisky holdings including Southern Comfort and Fireball Cinnamon.

The reason for mentioning these private distillers is that some are potential takeover targets, or some of these private companies might go after one of the smaller public companies.

Key Company Metrics

The following table provides the key metrics for the different distilling companies.

Table 3. Metrics for the six distiller companies as of the close of market March 17, 2017. Valuations are in USD. Financial figures are for the company 2016 fiscal years. USD to Euro conversion 0.95. USD to GBP conversion 0.80

Metric

Brown-Forman

Campari

Constellation Brands

Diageo

Pernod Ricard

Remy Cointreau

Mkt cap, $B

$18.2

$6.2

$31.7

$74.0

$30.1

$4.6

$/share

$46.79

$10.64

$161.75

$116.09

$115.79

$93.63

EPS, $

$2.64

$0.31

$6.46

$4.58

$5.01

$2.36

Trailing PE

17.7

34.7

25.0

25.3

23.1

39.7

Forward PE

25.0

-

21.5

20.6

-

29.7

PEG

5.4

-

1.4

2.3

-

2.5

Revenue, $M

$3089

$1818

$6548

$13106

$9139

$1106

Net income, $M

$1047

$336

$1765

$3551

$2397

$188

Operat Mrgn, %

33.9

18.5

27.0

27.1

26.2

17.0

ROA,%

14.5

5.0

7.8

7.3

4.7

5.1

P/B

15.2

3.4

4.6

6.3

2.1

3.7

DE

1.88

0.58

1.23

0.91

0.69

0.56

Dividend, $

$0.73

$0.11

$1.60

$2.38

$2.20

$1.89

DY, %

1.6

1.0

1.0

2.1

1.9

2.0

Div Payout, %

26

42

23

34

40

72

Income Statement Comparisons

There is considerable variation between the companies in terms of market cap and financial performance. They are all profitable, but one thing that stood out for me was the difference in profitability, especially Operating Margin (adjusted operating income as a percent of net revenue), which ranged from 17% to 34%. I wanted to take a closer look why some companies had higher profit efficiency than others. Greater efficiency in generating profits is assumed to be a positive investment signal. There are usually three main components of expenses on consolidated income statements:

Cost of sales: production costs including raw materials, processing and labor marketing and advertising: usually includes distribution and promotion Overhead (SG&A): head office and other general expenses.

Following is a breakdown in income statement numbers for 2015 and 2016 for the six companies. Click on the company name for the link to their financial statements: Brown-Forman, Campari, Constellation Brands, Diageo, Pernod Ricard and Remy Cointreau.

Table 4. Information derived from company consolidated income statements for 2015 and 2016 fiscal years. Net sales (revenue) is after excise tax was deducted. Operating income is adjusted for non-recurring items. Line items named as per company income statement.

Brown-Forman

2015, USD millions

2016, USD millions

Net sales (revenue)

$2991

% net sales

$3089

% net sales

Cost of sales (goods)

($951)

30.3%

($945)

30.6%

Advertising

($437)

13.9%

($417)

13.5%

SG&A (overhead)

($697)

22.2%

($688)

22.3%

Operating income

$1027

32.8%

$1047

33.9%

Campari

2015, Euros millions

2016, Euros millions

Net sales (revenue)

€1057

% net sales

€1727

% net sales

Cost of sales (goods)

(€740)

44.7%

(€742)

43.0%

Advertising/Promotion

(€286)

17.3%

(€309)

17.9%

Overhead (SG&A)

(€298)

18.0%

(€324)

18.7%

Operating income

€310

18.7%

€319

18.5%

Constellation Brands

2015, $US millions

2016, $US millions

Net sales (revenue)

$6028

% net sales

$6548

% net sales

Cost of sales/products

($3449)

57.2%

($3606)

55.1%

SG&A

($1078)

17.9%

($1177)

18.0%

Operating income

$1500

24.9%

$1765

27.0%

Diageo

2015, GBP millions

2016, GBP millions

Net sales (revenue)

£10813

% net sales

£10485

% net sales

Cost of sales (goods)

(£4610)

42.6%

(£4251)

40.5%

Marketing

(£1629)

15.1%

(£1562)

14.9%

Other operating

(£1777)

16.4%

(£1831)

17.5%

Operating income

£2797

25.9%

£2841

27.1%

Pernod Ricard

2015, Euros millions

2016, Euros millions

Net sales (revenue)

€8558

% net sales

€8682

% net sales

Cost of sales (goods)

(€3262)

38.1%

(€3311)

38.1%

Advertising/Promotion

(€1625)

19.0%

(€1646)

19.0%

Structure (SG&A)

(€1433)

16.2%

(€1448)

16.7%

Operating income

€2238

26.2%

€2277

26.2%

Remy Cointreau

2015, Euros millions

2016, Euros millions

Net sales (revenue)

€965

% net sales

€1051

% net sales

Cost of sales (goods)

(€347)

36.0%

(€385)

36.6%

Distribution

(€374)

38.8%

(€407)

38.7%

Administration

(€89)

9.3%

(€82)

7.8%

Operating income

€157

16.2%

€179

17.0%

The above table shows that Brown-Forman has the best operating margin, while Campari and Remy Cointreau have the worst. Constellation Brands, Diageo and Pernod Ricard are pretty similar in the middle of the pack.

So what are the reasons for the differences? Cost of sales includes a number of items including raw materials for manufacturing and manufacturing costs including labor, and it sometimes includes distribution costs. Advertising and marketing usually includes distribution costs as well as the other obvious costs. SG&A includes administration costs and sometimes advertising. It is worth noting if a company has higher costs than its competitors in any of these areas. With all these expenses, advertising and labor are potentially the most variable, so these are the first ones to look at.

Table 5. Distiller company employee and marketing efficiency in 2016.

Metric

Brown-Forman

Campari

Constellation Brands*

Diageo

Pernod Ricard

Remy Cointreau

Operating margin, %

33.9%

18.5%

27.0%

27.1%

26.2%

17.0%

Revenue, USD M

$3089

$1817

$6548

$13106

$9139

$1106

Marketing, USD M

$417

$325

?

$1953

$1733

$428

Rev/marketing $

$7.41

$5.59

?

$6.71

$5.27

$2.58

# employees

4600

4000

9000

33000

18230

1106

Rev/employee, USD K

$672

$454

$728

$397

$501

$704

* Advertising, marketing and distribution costs are not clear from the Constellation Brands income statement.

Advertising and Marketing Budget

My assumption was that alcohol companies like to advertise. You only need to turn on the television to see that! With regard to distillers, it is true that they spend a lot on advertising and marketing: about $1 for every $2-8 of revenue as per above. But the range is quite large and you have to ask the question, why spend $1 in advertising for $2 in revenue when some of your competitors only spend $1 in advertising for $8 in revenue? Advertising may not always pay since the distillers that spend relatively less on advertising tend to have higher operating margins, as Figure 1 (derived from data in Table 5) clearly illustrates. Therefore, you have to give value to companies that have a higher efficiency in using advertising and marketing spending to generate revenue.

Figure 1. Distiller Operating Margin vs. Revenue per Marketing $, 2016.

It appears that companies are recognizing that you can still achieve good revenue with less advertising. Both Brown-Forman and Diageo decreased their advertising spend in 2016 and yet revenues were still higher than in they were in 2015. Perhaps they are spending their advertising dollars more wisely - I haven't looked at that.

Cost of Sales

Brown-Forman has the lowest cost of sales as a percent of revenue of the six companies. This comparison is not completely valid since cost of sales components are not identical for each company, however, the low cost of sales for Brown-Forman is a main contributor to their higher operating margin. Cost of sales has two main components: raw materials and labor. Perhaps Brown-Forman has lower ingredient costs or perhaps they have a higher labor efficiency. Cost of ingredients for a company is usually not stated, but the number of employees is.

Revenue per Employee

A metric that I like to use when comparing companies is revenue or profit generated per employee. Within sectors this can be a measure of the efficiency with which employees are utilized which is a measure of management quality - see Figure 2 (derived from data in Table 5).

Figure 2. Distiller Operating Margin vs. Revenue per Employee, 2016.

There is no statistical relationship there. Brown-Forman does have fairly high revenue per employee, as does Constellation Brands and Remy Cointreau, so they are all good with regard to labor efficiency. Note that Diageo has the lowest revenue per employee and I have the impression that they are inefficient in that regard (more about that later).

Specific Comparisons between Brown-Forman, Constellation Brands and Diageo

Since this article is mainly about the U.S. traded distillers, I want to focus on the performance of those three. It is useful to look at how each of these companies has done over the past 5 years (since 2012) in terms of change in stock price, revenue growth, earnings per share and debt management.

Table 6. Five-Year Performance comparisons for Brown-Forman, Constellation Brands and Diageo. Change in stock price is from April 2012 to March 2017.

Metric

Brown-Forman

Constellation Brands

Diageo

Change in stock price, %

100%

800%

40%

Change in revenue, %

3.6%

14.5%

1.1%

Change in EPS, %

15.0%

14.5%

3.2%

Change in debt, %*

50%

245%

2%

Change in Debt/Equity*

57%

6%

(16%)

* 4 years (2013 to 2016)

Constellation Brands has had good growth and a spectacular increase in stock price. Earnings per share have also increased but only proportional to the revenue increase indicating no real improvement in operating efficiency. Brown-Forman, on the other hand, has had a good increase in price, a moderate improvement in revenue but a very good improvement in earnings which partly indicates improving operating efficiency improvements (it should be noted though that part of this is due to share buybacks). Diageo has shown little progress in revenue growth or earnings but was able to pay down some debt relative to equity.

Investment Case for Brown-Forman

Current Situation

Here is the stock chart for the last 5 years. They have done well, doubling from 2012 to 2015, although they have been flat the last couple of years.

Chart courtesy of StockCharts.com

Brown-Forman does have one of the highest debt levels (Debt/Equity and Price/Book) of any of the distillers, yet they also have one of the highest operating margins. What are they doing with that money if they are not paying down debt? They are only paying about 25% of earnings as dividends so that is not the reason. In 2015 and 2016 they acquired new international whisky companies. As well, they are buying back stock. In 2016 they spent over $1 billion (almost all their earnings) to buy back stock and over the last 4 years they have reduced outstanding shares by 15% (60 million shares). The Board has obviously calculated that stock buybacks are better than reducing debt and who is to argue with that? Perhaps they eventually want to go private! Owning the stock now might be an interesting ride in that regard.

Brown-Forman is also redesigning their brand portfolio. They sold Southern Comfort whisky and Tuaca brandy to Sazerac, and they got serious about the Irish and Scotch whisky markets. In 2015 they bought Slane Castle Irish Whisky and are investing $50 million in a new distillery there. In 2016 they bought GlenRiach, a single malt premium Scotch whisky company with three distilleries: GlenRiach, Glendronach and Glenglassaugh. They paid a premium price as well which is an indication that they are looking at the long term. They have also hired a top-notch Scotch whisky maker to replace the retiring previous owner and are investing in infrastructure. Glenglassaugh distillery restarted in 2008 after being mothballed. It will take a few years for the increased production from all three distilleries to hit the market and contribute to earnings. In the meantime, lost revenue from the Southern Comfort and Tuaca sales will depress earnings a bit as was indicated by the company in early March when they reported third quarter 2017 results. Clearly, the conclusion is that Brown-Forman is taking a longer term view of the business.

Things to Like About Brown-Forman

Jack Daniels is the world's number one Tennessee/Bourbon type whisky. Of course in the U.S., these are the main whiskies and in 2016 Jack Daniels had a 10.47% market share of all whisky types. As well, Jack Daniels sales increased 3% last year which is competitive to the 4% sales increase for all bourbon whiskies when you consider the increase in craft and specialty type whiskies. There is a lot to like about their American whisky business.

I also like what they are doing with single malt scotch whisky and what they have done with tequila. They are producing premium brands which are selling at premium prices. Herradura tequila and Glendronach scotch have excellent market recognition.

Things to Not Like About Brown-Forman

I don't like the low dividend. Also, they don't have a rum brand, but considering that rum is a very competitive market, perhaps they are wise to stay away and focus on the high margin products.

Conclusion and Target for Brown-Forman

The two best things about Brown-Forman are the continuing high profitability (operating margins) and growing earnings per share. They are in the position of generating a lot of cash and they seem to know how to best spend that cash in acquisitions and share buyback. Both are positive for shareholders. Assuming that share buybacks will continue in this pace, I expect an annual 10% increase in stock price. They have taken on extra debt, but they have a lot of flexibility to divert cash away from share buybacks towards debt reduction if they need to.

Investment Case for Constellation Brands

Current Situation

Here is the stock chart for the last 5 years. From 2012 to the middle of 2016 the stock price has increased from $20 to $160 - an 800% increase! In the last year the stock price has been flat.

Chart courtesy of StockCharts.com

It's hard to make apples to apples comparisons of Constellation Brands to Brown-Forman and Diageo, since so much of their product line is wine and beer. Certainly Diageo does have Guinness and Brown-Forman does have some wine, but these two companies are primarily distillers while Constellation is not (only 5% of revenue comes from spirits).

Constellation is mainly regarded as a U.S.-focused business, although 60% of their revenue comes from international sales - mainly due to a strong international wine business. The major beer brands in the U.S. are Corona, Modelo and Pacifico. Their major U.S. wine brands include Robert Mondavi and Woodbridge. They also have extensive wine holdings in Italy, New Zealand and Canada. Their sales growth is impressive and is mainly due to acquisitions, especially the 2013 acquisition of the Corona, Modelo and Pacifico beer brands in the U.S. Consequently they have accumulated a lot of debt, which has largely been neutralized by increasing equity.

Things to Like About Constellation Brands

Investors like the stock return - it has increased 8 fold in the last 5 years. The company has more than doubled revenue and their operating margin has improved from around 18% to 27%.

Things to Not Like About Constellation Brands

They are not spending money on paying dividends so don't look here for income. Investors will need to decide whether Constellation Brands has continued growth potential. I don't like the debt load. In the 2014 fiscal year they added $3.6 billion in debt for their Mexican beer purchase. As well, they have issued more stock.

The potential Trump Border Tax could impact their sales of Mexican beer in the U.S., but that is pretty speculative. If we have learned anything in the last couple of months, it is to look at what President Trump does, not what he says he is going to do.

Conclusion and Target for Constellation Brands

They have had a good run in expansion, but I am not sure about the future. In the fall of 2016 they sold their Canadian wine business to the Ontario Teacher's Pension Fund. Constellation has partnered with them and continues to run marketing and distribution. Ontario Teachers paid over $C 1 billion for the Canadian wine business. Constellation Brands initiated the sale which is an indication that either they felt that they could get a very good price and/or they wanted to reduce debt levels. Overall, I think that Constellation Brands did well on this transaction.

I don't see much in the way of continued growth or signs of improved operating efficiencies. I anticipate that they will focus on debt reduction. In this market, I expect the share price to increase less than 5% over the next year. I will pass on investing in Constellation Brands for the time being.

Investment Case for Diageo

Current Situation

Here is the stock chart for the last 5 years. They have not done that well. The stock price went up in 2013/2014 but it has been pretty flat since then.

Chart courtesy of StockCharts.com

There are a few things happening with Diageo, but not a lot compared to Brown-Forman and Constellation Brands. They have announced a new Guinness Brewery in Maryland. Also, there is some talk that they will increase their holdings in United Spirits, an Indian distilling company. The proposed Trump Border Tax could impact their U.S. sales. Also, given that they are a U.K. based company, the ongoing fallout from Brexit could further weaken the British pound which could help sales. It is not reasonable to price either the Trump or Brexit events into their investment thesis yet given the uncertainty.

Things to Like About Diageo

Their dividend (2.1% DY) is better than Brown-Forman's and Constellation Brands' but it is still not great. Recently they have been using cash to pay down debt to some extent.

Things to Not Like About Diageo

They are not growing quickly. Revenues are flat and their operating margin has actually decreased from 29% in 2013 to 27% in 2016. Their labour efficiency is not good, and overall I get the impression that Diageo is a top heavy and sluggish company.

Also, they are a U.K. company which is co-listed on the NYSE. Therefore, currency exchange risk will affect stock price and dividends.

Conclusion and Target for Diageo

There is little growth and no signs of improved operating efficiency, so I am not interested.

Rankings

None of the three companies are screaming bargains at the moment, which is not surprising in the high price market we are in. I don't consider any of these stocks to be good dividend investments, so the investment arguments are based on the quality of their metrics and their growth prospects.

Company

Rank

Current Price

Analyst Target Price, 1 year

My Target Price, 1 year

My Target total 1 year return

Brown-Forman

1

$47

$47

$52

12%

Constellation Brands

2

$162

$180

$169

6%

Diageo

3

$116

$122

$117

2%

I am a little more optimistic about Brown-Forman than the analysts. I think that analysts are expecting the acquisition/divestiture shakeout to last a little longer whereas I am more interested in their long-term growth potential and better operating margins. I am also more pessimistic about the Constellation Brands and Diageo than the analysts, also due to their limited growth potential and poorer operating margins. Should you buy these stocks? I am not qualified to make recommendations to others, but for my own investments, the answer is yes for Brown-Forman and no for the other two. My view of Brown-Forman is that the stock is a buy and hold for the long term.

Disclosure: I am/we are long BF.B.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

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