Brown-Forman: Too Expensive For A Value-Oriented Portfolio

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About: Brown-Forman Corporation (BF.B), BF.A
by: AllStarTrader
Summary

Brown-Forman has long been a desired position for my portfolio.

However, the shares always seem expensive versus the fundamentals.

Growth is not making up for the premium shares currently have, and investors would do well to wait for this one to pull-back.

Image result for brown forman

Source

Brown-Forman (NYSE:BF.B) shares are trading at a valuation that implies significant growth in operating metrics. Despite this, the company recently reported a quarter that showed less than inspiring growth. The company owns a recognizable portfolio of brands and has benefited from the growth in whiskey drinking over the past few years. However, as a value/dividend oriented investor, Brown-Forman is not and has not for some time shown an entry point that would be attractive. The stock has been in a sideways trading pattern for quite some time, ignoring market swings up and down for the most part. For the company to find its shares in my portfolio, it would need to either yield 2.5%> or offer significant value. We will review where this may be below.

Performance

Brown-Forman recently reported earnings that missed on the top line but beat on the bottom.

Source: Seeking Alpha

The company saw revenue growth of 1.5%, not exciting. However, the company attributed 2 points of this to currency headwinds and another whole point to tariffs. The company saw the most growth in the emerging markets segment, followed by developed international markets, and the United States. On a positive note, each one of the markets it operates in saw growth. Important to note is that the company does continue to expect underlying sales growth of 5-7%. Yet, with this, the company only expects to earn $1.75 to $1.85. This means with shares currently at $54 per share that they trade at a multiple of 30 times 2019 earnings. And, while management believes they will return to high single-digit operating income growth beyond fiscal 2020, this isn't the double digits one would expect from a company with such a lofty multiple.

Looking at the last 10 years of revenue and net income trends, we see the company has been growing.

Source: Seeking Alpha

Albeit, revenue has only grown 31% and net income 64%. This is growth, but not rapidly accelerating growth. I don't typically look for fast growing companies due to lofty multiples and the hit they take when growth decelerates. However, it appears here the investor demand for a quality company with recognizable brands has put a floor under the shares.

The company has some notable brands that are benefiting from significant growth in the categories they are in.

Source: Investor Day Presentation

The company has outlaid a focus on this growth below.

Source: Investor Presentation

The current market for distilled spirits in the U.S. stands at about 52% share for whiskey. Brown-Forman only has around 6% of this market, which should leave plenty on the table for growth. While the company has a strong family ownership of shares preventing it from being acquired, it does not stop the company from acquiring others as it sees fit. In fact, this is what investors should hope for as a way to turn up the earnings the company is delivering.

The balance sheet currently stands with $2.44 billion in debt as of 4/30/2019, and with only around $250 million in cash, this is not the strongest capital position to be in to pursue acquisitions. The last acquisition it did was in 2016, which should leave investors happy knowing the company doesn't just buy brands for the sake of growth. The right deal at the right time says a lot about management. The current capital position doesn't warrant concern due to the stability in revenue even during economic recessions. But it should be looked to for improvement as it is not as strong as it could be.

Valuation

Compared to peers, BF.B is trading at a premium.

Chart Data by YCharts

The shares trade with the highest forward P/E, highest P/S, and almost the lowest yield. This means they may have room to fall should they fall in line with peers.

Another way to look at valuation is through historical trading levels.

Source: Morningstar

In the last 5 years, we can see where shares would typically be at from a valuation perspective. Currently, shares trade at a premium to their own historical P/S, P/E, P/CF, P/B, and forward P/E. This tells me that the shares once again may have room to fall as there is no significant growth expected.

One more thing to identify if shares offer value is the historical yield.

Source: Yieldchart

In the last 24 years, shares have offered an average yield of 1.83%. Currently, they only offer a yield of 1.28%, which is within striking distance of the abnormally low yield noted on the chart. If shares were to move back to a yield that is average, shares would trade around $35, 40% lower than here.

Conclusion

Brown-Forman operates an excellent portfolio of brands in a recession-resistant environment. With growth expected to continue in all of the categories it operates in, the company certainly should see higher revenue and earnings in the coming years. However, as a value investor and income-oriented investor, shares offer no enticement of either at this time. Should shares pull back to offer an above-average yield or a lower than historical average valuation, I would review again. At this time, there are other options for investments in the alcoholic beverage space with better yields and or valuations. Investors should also note there is a class of super-voting stock controlled by the family under ticker BF.A.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.