Brown-Forman Corporation - Nothing Better

Brown-Forman – Nothing Better?

When I wrote my December 13, 2016 Brown-Forman Corporation Stock Analysis: Enriching Life? Not Lately! post, the company’s slogan was Enriching Life. Now, the company’s slogan is Nothing Better. If Brown-Forman (BF) is talking about its investment performance, nothing could be further from reality.

While BF is a Dividend Aristocrat, dividend metrics have no bearing on my investment decision making process. My interest lies in total potential shareholder return.

NOTE: Brown-Forman has had two classes of shares since 1959 when the company’s stockholders approved the issuance of two shares of Class B non-voting common stock to every holder of Class A voting common stock; BF-A shares are very thinly traded, and therefore, any reference to BF is based on BF-B shares.

The Class A common stock has full voting powers, including in the elections of directors. The Class B common stock may not vote except as provided by the laws of Delaware.

The Brown family controls a majority of BF’s voting stock. Collectively, they have the ability to control the outcome of stockholder votes. This includes the:

  • election of all of directors; and
  • approval or rejection of any merger, change of control, or other significant corporate transactions.

Business Overview

BF was founded in 1870 and became a publicly traded company in 1933.

It primarily manufactures, distills, bottles, imports, exports, markets, and sells a wide variety of beverage alcohol products under recognized brands. Its portfolio of more than 40 spirit, ready-to-drink (RTD) cocktail, and wine brands includes its iconic Jack Daniel’s Tennessee Whiskey brand, the #1 selling American whiskey in the world.

The following list of BF’s principal brands is found in the FY2024 Form 10-K.

BF-Principal-Brands

As part of my investment decision making process, I look at whether a company’s products or services is beneficial to society. When I determine that a company adds no value to society, I typically pass and move on.

In the case of BF, I find that its products offer no benefit to society; BF’s products even when consumed in moderation impair a consumer’s cognitive abilities.

While BF prides itself in using grains, grapes, agave, and clean water as its essential ingredients, the health aspect of some of BF’s essential ingredients is subject to debate. Agave, for example, has more calories than common table sugar (60 per 3-teaspoon serving versus sugar’s 48). As with other sweeteners, too much agave can lead to:

  • obesity;
  • type 2 diabetes;
  • heart disease; and
  • tooth decay.

Financial Review

Q4 and FY2024 Results

FY2024 has been a challenging year for just about every participant within the spirits industry; key competitors such as Constellation Brands, Diageo plc, and Pernod Ricard SA have all experienced challenges.

On June 5, 2024, BF released Q4 and FY2024 results and its FY2025 outlook. This information is accessible on the company’s website. The following images from the Earnings Presentation are provided for ease of reference.

BF-FY2024-Results
BF-Net-Sales-Growth-FY2020-FY2024
BF-FY2023-and-FY2024-Results-Reconciliation

Operating Cash Flow (OCF) and Free Cash Flow (FCF)

I view acquisitions and divestitures separately from CAPEX required solely to ‘maintain the business’.

An example of an acquisition I exclude in determining necessary CAPEX, is the November 3, 2022 acquisition of the Gin Mare and Gin Mare Capri brands through the purchase of 100% of the equity interests of Gin Mare Brand, S.L.U., and Mareliquid Vantguard, S.L.U.; both are Spanish companies.

The November 1, 2023 sale of the Finlandia vodka business to Coca-Cola HBC AG for $0.196B in cash, for example, is a non-recurring item. I, therefore, exclude such a sale when determining the level of OCF and FCF I can expect BF to generate in the coming years.

A quick indicator of how much company must spend to ‘maintain assets in good operating condition’ is to look at annual depreciation.

In FY2014 – FY2024, BF generated:

  • OCF of (in billions of $): 0.649, 0.608, 0.524. 0.656, 0.653, 0.800, 0.724, 0.817, 0.936, 0.640 and 0.647.
  • FCF of (in billions of $): 0.520, 0.483, 0.414, 0.541, 0.525, 0.679, 0.611, 0.755, 0.798, 0.457, and 0.419.

Annual CAPEX was (in billions of $) 0.129, 0.125, 0.110, 0.115, 0.128, 0.121, 0.113, 0.062, 0.138, 0.183, and 0.228 during the same period. Management’s FY2025 outlook includes planned CAPEX of ~$0.195 – ~$0.205.

Return On Invested Capital (ROIC)

The trend in BF’s ROIC is not encouraging. In FY20214 – FY2023, BF’s ROIC (%) was 23.85, 22.87, 35.69, 21.55, 20.63, 22.59, 20.55, 19.79, 17.53, and 15.11. In FY2024, this had dropped to ~13.3%.

High quality companies often generate a high ROIC. If a company generates a high ROIC, it needs to invest less to achieve a certain growth rate thus reducing the need for external capital.

A company that generates $0.15/profit for every $1 invested, for example, achieves a ROIC of 15%. I consider a ~15%+ ROIC to be a reasonable minimum threshold because most of the time, a company’s cost of capital will be lower than this level.

When a company consistently generates a high ROIC over the long term and it is growing its revenue, it can reinvest a portion of its profits under favorable conditions thereby leading to a compounding effect. I would much rather invest in a growing company that can reinvest to create greater shareholder value than to invest in a company that has limited growth opportunities and thus chooses to distribute a growing dividend.

FY2025 Outlook

BF expects the global macroeconomic and geopolitical uncertainties to persist which will create a challenging operating environment. A return to growth for organic net sales and organic operating income is driven by gains in international markets and the benefit of normalizing inventory trends has led it to provide the following FY2025 outlook:

  • Organic net sales growth of 2% – 4%;
  • Organic operating income growth of 2% – 4%;
  • An effective tax rate of ~21% – ~23%; and
  • Planned CAPEX of ~$0.195B – ~$0.205B.

These growth levels reaffirm that BF is a slow growth business.

Risk Assessment

Any investment entails an analysis of risk/reward. Far too often, however, the risk aspect of an investment is overlooked or the investor overestimates their risk tolerance.

Looking at BF’s debt and credit facilities, we see that debt repayments over the next several years are manageable.

BF-FYE2023-and-FYE2024-Debt-and-Credit-Facilities

Credit rating agencies certainly don’t always ‘get it right’. I do, nevertheless, compare their assessment of a company’s risk with my assessment.

Since September 20, 2011, Moody’s has assigned an A1 rating to BF’s domestic senior unsecured debt. S&P Global, however, has assigned an A- rating since November 28, 2012. This is a 2 tier disparity!

The rating assigned by Moody’s is the top tier of the upper medium grade investment grade category while that assigned by S&P Global is the bottom tier of the upper medium grade investment grade category.

The outlook from both is ‘stable’.

Despite the disparity in BF’s credit ratings, both define BF as having a strong capacity to meet its financial commitments. The company, however, is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than obligors in higher-rated categories.

Dividends and Share Repurchases

Dividends and Dividend Yield

BF has paid regular quarterly cash dividends for 80 consecutive years and has increased the regular dividend for 40
consecutive years. The dividend history reflected on the company’s website, however, currently only dates back to 1989; BF has also declared a special dividend on 4 occasions during this time frame.

This dividend track record is small consolation if we step back and consider that BF’s total annual shareholder return over the past decade is sub 3.50% if the dividends had been reinvested; the return is slightly worse if the dividends had not been reinvested. Compare BF’s return to the US inflation rate over the past 10 years and we see that BF has disappointed its investors.

BF is scheduled to distribute its 3rd consecutive $0.2178/quarterly dividend on July 1; it will likely distribute the same amount in October. If we give BF the benefit of the doubt that it will increase its quarterly dividend by 10% when it declares its quarterly dividend in November, we can expect the next 4 quarterly dividend payments to total $0.9156 calculated as follows: (($0.2178 x 2) + ($0.24 x 2)). With shares trading at ~$43.55 as I compose this post, the estimated forward dividend yield is ~2.1%.

Share Repurchases

As noted earlier, some investors fixate on dividend metrics to their detriment. The focus should instead be on total investment return.

One means by which a company can improve shareholder return is through the opportunistic repurchase of issued and outstanding shares.

Let’s see how BF has done on this front.

In FY2014 – FY2024, BF’s weighted average diluted shares outstanding (in millions of shares rounded) was 538, 533, 511, 488, 484, 482, 480, 481, 481, 480, and 477.

Looking at BF’s share repurchase activity in FY2024, we see that the timing of the share repurchases was less than optimal! Keep in mind that I compose this post when BF’s share price is ~$43.55.

In October 2023, BF’s Board authorized the repurchase of up to $0.4B (excluding brokerage fees and excise taxes) of outstanding shares of Class A and Class B common stock from October 2, 2023, through October 1, 2024. Under this Repurchase Program, BF repurchased 175,632 Class A shares at an average price of $59.35/share and 6,736,658 Class B shares at an average price of $57.83/share, for a total cost of $0.4B. The program was completed in December 2023 and no further shares were repurchased between the end of Q3 and FYE2024.

Valuation

BF’s PE levels in FY2014 – FY2024 are 28.24, 30.45, 17.15, 35.77, 30.70, 38.19, 41.37, 45.54, 35.70, 35.25, and 20.65.

In FY2024, BF generated $2.14 in diluted EPS. Given the challenging business environment, I do not expect FY2025 results to be much different. Let’s, however, be generous and arbitrarily assign a 2% increase in BF’s diluted EPS results thus giving us ~$2.18 of diluted EPS in FY2025. With shares currently trading at ~$43.55, the forward diluted PE is ~20.

With shares currently trading at ~$43.55, the following is BF’s valuation based on the current brokers’ forward adjusted diluted EPS estimates:

  • FY2025 – 17 brokers – mean of $1.83 and low/high of $1.75 – $1.98. Using the mean estimate, the forward-adjusted diluted PE is ~23.8.
  • FY2026 – 15 brokers – mean of $1.98 and low/high of $1.91 – $2.18. Using the mean estimate, the forward-adjusted diluted PE is ~22.
  • FY2027 – 7 brokers – mean of $2.17 and low/high of $2.07 – $2.40. Using the mean estimate, the forward-adjusted diluted PE is ~20.

Let’s look at BF from a P/FCF perspective.

BF generated ~$0.419B of FCF in FY2024 and there were 477,220 million diluted shares outstanding in FY2024 thus giving us ~$0.88 in FCF/share. With shares trading at ~$43.55, the P/FCF is ~49.5.

If BF were to generate $0.5B of FCF and to reduce its diluted shares outstanding to 450 million, we get ~$1.11 of FCF/share. With shares trading at ~$43.55, the P/FCF is ~39.2 which I think is high for a business that is growing very slowly.

Final Thoughts

Wealth is often created when we opportunistically acquire shares in great companies that have temporarily fallen out of favor. Despite BF having fallen out of favor with investors, I see no reason why I would want to initiate a position.

I do not dispute that BF’s risk is acceptable and that shares are significantly undervalued. What turns me off from the company is that its products are unhealthy and contribute to some of society’s current problems.

BF products are unnecessary expenditures and many BF consumers would do well to stop consuming this ‘garbage’. Furthermore, if consumers need to ‘tighten their belts’, the consumption of BF’s alcoholic products is likely to suffer.

Although BF has several recognizable brands, the wineries and distilleries industry is highly competitive. I do not think that BF can significantly increase its prices, and therefore, do not expect any meaningful top line growth; management’s outlook supports this observation.

BF’s lengthy history of distributing a dividend and increasing its dividend should have no bearing on your investment decision. The past is the past. Furthermore, the ever increasing distribution of dividends implies that management does not think the retention of funds in the company is likely to be the best means by which to generate superior long-term shareholder returns.

In his book ‘Mastering the Market Cycle – Getting The Odds On Your Side’, Howard Marks (cochairman and cofounder of Oaktree Capital Management) discusses the importance of:

  • studying past cycles;
  • understanding their origins; and
  • the need to remain alert for the next one.

Although I have absolutely no idea what is likely to occur in the current investment environment, I think many investors are investing based on their emotion of greed. Tossing caution to the wind is likely to result in them being blindsided by unexpected events.

The cash I have accumulated on the sidelines is being held with the expectation that several great companies that are currently richly valued will become more attractively valued at some point. These companies, in my opinion, have the potential to generate total average annual shareholder returns over the long-term that are well in excess of what BF is likely to generate. I, therefore, have no intention of initiating a BF position.

I wish you much success on your journey to financial freedom!

Disclosure: I do not have Brown-Forman exposure and have no intention of initiating a position. I disclose holdings held in the FFJ Portfolio and the dividend income generated from the holdings within this portfolio. I do not disclose details of holdings held in various tax-advantaged accounts for confidentiality reasons.

Author Disclaimer: I do not know your circumstances and do not provide individualized advice or recommendations. I encourage you to make investment decisions by conducting your research and due diligence. Consult your financial advisor about your specific situation.

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I am a self-taught investor and run the Financial Freedom is a Journey blog. I have invested in the North American equities markets for over 34 years. I retired from a career in banking and continue to invest as this is something about which I am passionate.

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