A closer look at Brown-Forman

Continuing my series on digging into five of the premier global luxury-goods companies...

In my November 12 e-mail, after I took a bike tour of New Zealand's main wine-producing region, I wrote:

There are more than a dozen publicly traded winemakers – most notably diversified spirits giants like Constellation Brands (STZ), Diageo (DEO), Brown-Forman (BF-B), and Paris-based companies LVMH (MC.PA) and Pernod Ricard (RI.PA). These are all high-quality businesses with strong global brands, so this is also an opportunity to take a look at their stocks.

On November 14, November 21, and November 22, I did a deep dive on LVMH... and yesterday, I looked at the financials of Constellation.

So today, let's do the same for Brown-Forman, which is best known for its Jack Daniel's whiskey. As I wrote on November 13 when I took a first look at the company:

It was one of the greatest stocks of all time through its peak in late 2020, but since then, it has been cut in half:

And as I continued when I turned to the company's revenue and operating income:

The stock's performance over the past four years doesn't align with the company's financial performance, which has been solid, albeit uninspiring:

At first glance, based on these two charts, I would guess that Brown-Forman is another stock that became overvalued such that, when growth slowed, the multiple that investors were willing [to] pay declined – as did the stock.

Then came the question of valuation:

When it comes to valuation, as of yesterday's close Brown-Forman has a $19 billion market cap and $3 billion of net debt, which gives it a $22 billion [enterprise value "EV")]. The stock is trading at 5.3 times revenue, 17.5 times [earnings before interest, taxes, depreciation, and amortization ("EV")], and 22.6 times this year's estimated earnings per share.

After what I saw at a first glance of Brown-Forman, I was disappointed by what I found. The company hasn't shown much growth over the past decade – but despite getting halved, the stock was trading at rich multiples.

However, out of the group, I was still intrigued enough to keep it on my radar.

When I shared that first brief overview on Brown-Forman last month, the stock had closed at $40.66 per share the day before. Yesterday, it closed at $43.70 per share... a more than 7% pop.

Once we look deeper at the numbers, the story might be more compelling – so let's dig into more of them today...

As always, the next step into my deeper dive on a company's financials is to look at the cash-flow statement and, in particular, free cash flow ("FCF"). In the chart below, you can see Brown-Forman's historical operating cash flow, capital expenditures ("capex"), and FCF:

Here, we can see that the story is similar to the income statement – though even less inspiring. Brown-Forman showed almost no growth in FCF from 2007 to 2017... then modest growth through 2021... and then a pullback during the past two and a half years to levels first achieved in 2007.

Selling premium branded spirits is a fabulous business, with exceptionally high gross and operating (pretax) margins. This next chart shows the margins at Brown-Forman:

But the trend here isn't what I want to see, as margins have actually trickled downward over the past decade.

Turning to the balance sheet, Brown-Forman's net debt has risen modestly... but isn't of concern given the size and stability of the company's cash flows:

For "cash cow" companies like this, capital allocation is critical – so let's look at how Brown-Forman has allocated its FCF:

This is a bit of an odd mix, not a consistent strategy.

For example, when it comes to big acquisitions, almost two decades ago Brown-Forman acquired Casa Herradura, a leading Mexican tequila producer, for about $800 million. In 2016, it made a small acquisition of a Scottish whisky business called BenRiach Distillery for a bit more than $400 million. And in most recently, it spent about $1.2 billion to purchase ultra-premium brand Gin Mare and super-premium brand Diplomático Rum.

Brown-Forman has paid steadily rising dividends (the stock currently yields about 2.1%), with an unusually large double-dividend in 2021.

And share repurchases are all over the map, with a surge from 2014 to 2016 and a spike all of a sudden a year ago. As a result, the share count has declined 18% in the past two decades – less than 1% annually:

Overall, after reviewing all these financials, Brown-Forman looks like a classic high-quality cash-cow business. But it has shown little growth... its capital allocation has been uninspiring... and I'm not seeing any new line of business or big trend that's likely to change this.

In particular, given the explosion of wealth across the globe among the elite, other luxury-goods businesses – such as LVMH – that serve high-end customers have been able to grow their top line and margins substantially over the past couple decades... meaning their profits have soared. So I was surprised and disappointed that Brown-Forman hasn't done the same.

With the caveat that I haven't met management, the financials tell me that this is likely an undermanaged business.

Turning to valuation, the stock has risen a bit since I last wrote about it – so as of yesterday's close Brown-Forman has a roughly $20.6 billion market cap and about $2.8 billion of net debt, which gives it an EV of around $23.4 billion. The stock is trading at about 5.7 times revenue, 18.6 times EBITDA, and 24.0 times this year's estimated earnings per share.

Combined with the financials, that valuation is simply too high to interest me...

My instinct and experience tell me that fair value for a stock like this might be 18 to 20 times current-year earnings, meaning I would only be interested in buying it at, say, 13 to 15 times earnings. (Normally I look for 50-cent dollars, but I would pay closer to intrinsic value for a high-quality business and low-risk stock.)

So I'll keep an eye on Brown-Forman and hope the stock gets whacked by a bad quarter or two... At that point, the valuation might get low enough where it looks like a good buy.

It might not be compelling enough now... but it's worth keeping on the radar.

Best regards,

Whitney

P.S. I welcome your feedback – send me an e-mail by clicking here.