Brown-Forman Corporation

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 4/5

Brown-Forman, a global company, produces and markets a portfolio of alcoholic beverage brands, focusing on premium spirits, and is family-controlled since 1870.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Brown-Forman is a multinational producer and distributor of premium alcoholic beverages. Their primary revenue driver is their whiskey business, notably the Jack Daniel’s family of brands. They also have a substantial presence in the tequila, vodka, and wine categories. The company’s products are distributed across a vast global network, with significant regional strengths in the United States, Europe, and emerging markets.

Brands like Jack Daniel’s are crucial to Brown-Forman, demonstrating the importance of well-established, high-quality consumer preferences in brand power.

Their portfolio includes:

Jack Daniel’s Family of Brands (primarily Tennessee whiskey, but also other whiskeys and ready-to-drink products): A core offering within this is the traditional and well known Jack Daniels Black Label, which constitutes about two-thirds of the brand’s volume. But the company’s offerings also include Jack Daniel’s flavors, ready-to-drinks (RTDs), and other premium releases that make up the rest.
Premium Brands: This includes brands like Woodford Reserve, a high-end bourbon known for its rich flavor profile, and Herradura, a premium tequila. Other premium brands like Herradura and El Jimador tequila have performed well recently.
Other Spirits & Wine: This includes other liquors like Finlandia Vodka, and premium wines such as Sonoma Cutrer.

The company operates with a three-tier distribution model in the US, they sell to wholesalers who then resell to retailers. In international markets, the company has a mix of sales directly to distributors as well as sales to large regional retailers.

Brown-Forman’s commitment to sustainability is clear in their goals for reducing emissions and water use. Moreover, they are focused on promoting responsible drinking and acting ethically across their operations, underscoring a growing expectation from the public for sustainable business practices.

Industry Trends:

The global alcoholic beverage market is characterized by a shift towards premiumization, meaning consumers are increasingly willing to pay more for higher-quality and differentiated products. This favors companies like Brown-Forman with strong brands like Jack Daniel’s and Woodford Reserve.
There’s been a global shift in consumer preferences for premium and ready-to-drink (RTD) alcoholic beverages, with a particularly strong growth for RTDs. This change requires companies to continuously adapt to these changing consumption patterns.
The growth in the sector is geographically diverse, with emerging markets showing stronger growth while some developed markets showing a lower/negative growth trend.
Volatility in foreign exchange rates, as well as raw material and input costs can affect profit margins and present a risk for alcoholic beverage companies.
Increasing regulatory scrutiny and changes in taxation in various countries create an additional degree of uncertainty and challenge for the alcohol industry.

Competitive Landscape:

The alcoholic beverage industry is highly competitive, dominated by large multinational players like Diageo, Pernod Ricard, Anheuser-Busch InBev, and Constellation Brands as well as countless small players.
The competitive landscape includes companies focused on specific beverage categories such as beer, wine, or spirits, and those that are diversified across all categories.
Competition is often based on brand perception, product quality, distribution networks, and price.
Pricing pressures and the need to maintain distribution channels require constant innovation and significant investment into marketing and advertising.

What Makes Brown-Forman Different?

Family Control and Heritage: As a family-controlled business for over 150 years, the company has a long-term oriented approach that allows for long term decision-making, which helps them maintain their brand value and invest in their products. This also impacts their culture which values long term strategy over short term gains.
Concentration on High-End Spirits: Brown-Forman’s strong focus on premium spirits, particularly American whiskey, positions the company to capitalize on the global premiumization trend. A well-known brand such as Jack Daniels allows them to capture higher sales and margins.
Global Brand Recognition: They possess a wide network distribution that provides them access to a big global market, especially its presence in the United States. This allows the brands to gain market share.
Innovation: The company is continuously creating new products, particularly within the Jack Daniel’s line, giving consumers new choices while also creating more product loyalty.

Moat Analysis

Moat Rating: 3 / 5 While Brown-Forman possesses several characteristics that create a moat, they are not so strong that they can be considered to have a wide moat.

Intangible Assets: The most significant source of their competitive advantage stems from their strong brand recognition of Jack Daniel’s, and other high value brands such as Woodford Reserve and Herradura. These brands command significant pricing power and are very popular across their target demographics and markets. However, despite the strength, they are not unshakeable. There is a lot of competition in the beverage space and also the brand has been known to have slow/moderate growth.

As of 2023, Interbrand has recognized Jack Daniel’s as the 20th most valuable alcoholic beverage brand, with a brand value of $6.8 billion dollars. However, other brands such as Bud Light, Johnnie Walker, and Hennessy do have much higher brand value. This shows that even with a strong brand, it faces a lot of stiff competition from established brands.

Switching Costs: To some degree, the company also enjoys switching costs, particularly from consumers of their premium offerings. Customers who regularly buy specific high-end whiskeys from the brands may have a higher hurdle to overcome before changing to competing brands, especially if they have already developed a taste for the current brands. However, since consumers often try new brands in this space, this effect is usually less prominent and lasting.

The company’s reliance on just a few core brands also makes it more vulnerable if one of them suffers brand reputation damage, or declining consumer preferences.

Cost Advantages: In terms of cost advantages, the company doesn’t possess any special advantage. Other producers, in some cases, can get a cost advantage from their geographical locations, or vertical integration into the supply chain.

Legitimate Moat Risks and Business Resilience

Moat Risks:

Changing Consumer Preferences: There is a risk that consumer preferences could shift away from their core product, which is whiskey, and towards other categories such as clear spirits or RTDs, if they fail to adapt to those tastes.
Brand Reputation: Brands have been known to have issues in case of quality control problems, supply chain problems, or even due to bad company practices.
Competition: The alcoholic beverage industry is fiercely competitive. New products from established and newer companies can take away profits from the company if they don’t innovate their brands.
Emerging Markets: If growth from emerging markets falls short, there is a chance that their future growth would be underwhelming as many developed markets are stagnating or declining.
Financial Risks: Increasing interest rates will directly impact earnings by increasing the cost of debt. Also, it would likely increase the company’s cost of capital, requiring them to produce more profits for shareholder returns.

Business Resilience:

Strong Brand Portfolio: Brown-Forman’s strong brands, particularly Jack Daniel’s, help them in times of crisis and economic downturn. Strong brands can help retain market share in comparison to brands that are not strong enough to capture loyalty.
Global Reach: Brown-Forman’s global presence helps it to mitigate risks that might be caused by regional economic and consumer disruptions. They can make up losses from some geographies by making sales in other growing geographies.
Experience and Stability: Long operating history allows the company to be resilient to changes that might happen in the market or the economy. A company operating for 150+ years has seen various crises and has experience in dealing with them and still coming out stronger. Also, the long history of family control further adds to stability, since they will make more long-term oriented decision, instead of being focused on quarterly or yearly results.

Financial Analysis

Financial Health Rating: 4 / 5

Brown-Forman maintains a relatively strong balance sheet. While they do take debt for their operations, their debt to equity is well within normal boundaries. They are also generating profits from their core operations.

Revenue Distribution:

While Brown-Forman has international operations, a significant portion of revenue comes from the United States, with a substantial portion coming from Europe. In the last few years, the emerging markets have been contributing to their growth and are a core focus area for the future.

Margins:

Gross profit margins are relatively high due to their ability to command a premium price for their products. However, marketing and distribution costs (as with most alcohol brands) can be substantial and eat into the operating profits.
Their operating profit margin has varied widely over the years, from 11.2% in 2020 to 23.6% in 2023, owing to various factors like the recent cost inflation. This shows that there’s some degree of sensitivity to external factors, that are impacting their profit margins. But generally, their strong brand name allows them to be highly profitable when things are going well.

Financial Metrics:

The company reports diluted EPS on a yearly basis which was $1.46 in 2023 vs. $1.53 in 2022, showing a decrease. However, their net sales increased from 3.9 billion to 4.2 billion between 2022 and 2023.

While the EPS has decreased in 2023, their revenues show a good trend in which they are growing. The management has commented on a call that their profits are being affected by higher operating costs, but they are actively working to resolve this issue.

Their debt to equity ratio has consistently gone down over the last several years. Their long term debt was $2.5B in 2018 and has decreased to $2.2B in 2023. This highlights their focus on deleveraging and improving their balance sheet.
Their annual dividend payout is $0.82 per share in 2023, an increase of $0.05 over the 2022 payouts. They have also consistently paid dividends, indicating a commitment to shareholders.

The company’s strong cash flows show that they have a good ability to continue to support the dividends and reinvest in their business for organic and inorganic growth.

Their free cash flows has also shown to be consistently positive. In 2023, it was about $695M.

Other Important Items:

Management has stated that the focus is on maintaining a high margin-portfolio. To achieve this, they are focused on premiumization, pricing, and route-to-market strategies, particularly in emerging markets.
Brown-Forman has experienced supply chain disruptions in the past, but as the supply chain has stabilized, management seems confident in achieving its future goals.
Their management has also shown confidence in being able to navigate any external situations, especially with pricing power on their established brands.
Recently, there’s been a significant focus to expand sales into markets in Africa.
While they are expecting headwinds from lower interest expenses in the coming quarters, they are also focused on deleveraging.
Currency exchange rates are a critical factor in the business. Negative currency rates have impacted their results in the past. Management says that they will continue to monitor FX and hedge these positions to maintain profits.

Business Understandability

Understandability: 2 / 5 Brown-Forman’s business model, while largely understood, is affected by global dynamics that are difficult to interpret and understand.

Product Simplicity: As a company that provides alcoholic beverages, their product is easily understandable by average investors.
Distribution Strategy: They operate with a three-tier distribution model, with the company selling to wholesalers, who in turn sell to retailers.
Geopolitical Factors: A large amount of the company’s operations are international, and are therefore exposed to economic and political risks in foreign countries.
Currency Risk: Changes in foreign currency rate can cause major impact to profits and may also be hard to predict.
Market Complexity: Despite having a simple business model, the competition is fierce and brand loyalties can swing either way.

Conclusion

Brown-Forman is a well-established business with a rich history. They have a well-diversified portfolio with strong brands, a global footprint, and great management. But like all companies they are also exposed to external risks such as those pertaining to economy, industry, or regulations. Given these factors they are a strong company but not without some risks that they have to navigate. Also, their valuation at the moment might not be a great fit for all kinds of investors.