Brown-Forman (BF-B): America’s Whiskey King Is a Fast-Growing Dividend Aristocrat

Iconic brands can often make for solid long-term dividend growth investments, thanks to the wide competitive moats and strong pricing power that are created by brand loyalty.

 

In fact, Warren Buffett’s dividend portfolio consists of a number of companies with extremely well-known brands, from Apple to Heinz, Pampers, and Coca-Cola.

 

Another great example of a company that benefits from the strength of its brands is Brown-Forman (BF.B), whose Jack Daniel’s Whiskey has become synonymous with American culture.

 

In fact, with 32 straight years of dividend growth under its belt (at an impressive growth rate of 9% annually), Brown-Forman is a dividend aristocrat, and one whose 21.2% annual total returns over the past three decades have vastly outperformed the broader market.

 

Let’s take a closer look at America’s whiskey king to see just what makes its business so appealing, what kind of growth income investors can expect going forward, and whether or not shares could be worth buying today.

 

Business Overview

Brown-Forman was founded in 1870 in Louisville, Kentucky, by George Garvin Brown, a pharmaceutical salesman, and his accountant friend George Forman, with $5,500 in savings and debt ($97,000 in 2016 money).

 

Brown-Forman has since grown to become one of the world’s dominant spirits and liquor producers, marketing numerous premium alcohol products in over 165 countries.

 

 

Brown-Forman’s largest and most important market continues to the the U.S., which represented just under half of total sales in fiscal 2017. However, the company’s overseas presence, especially in fast-growing markets such as Mexico, represents its best future growth opportunities.

 

 

Business Analysis

Brown-Forman possesses several major competitive advantages that have fueled its long-term success.

 

First, the production of spirits like whiskey and bourbon take specialized skill and time. For example, whiskey needs to be aged at least two years in charred oak barrels, and the taste of individual brands is similarly specialized due to various tweaks created in the production process.

 

In other words, high end spirits are not a commodity product that upstart rivals such as America’s 1,300 or so craft distilleries can easily win market share in. In fact, those 1,300 small time operators have a total market share of just 3%, compared to Jack Daniels’ 30% domestic bourbon and Tennessee Whiskey market share.

 

The other wide moat factor is the name brand, which is highly important to industry consumers, who have historically proven to be less price sensitive and very brand loyal.

 

This is why Brown-Forman spends so much on advertising ($380 million or 13% of revenue in 2016).

 

With an operating history dating back over 100 years and billions of advertising dollars cumulatively spent, Brown-Forman has created a loyal following of consumers who have developed a preference for the taste of its whiskeys. This has helped the company consistently raise prices and maintain excellent profit margins.

 

When combined with the quality of its long-term focused management, currently headed by CEO Paul Varga (over 30 year of experience with Brown-Forman), the results have been impressive, with over 61 years of consistently strong volume growth.

 

 

Another major advantage is Brown-Forman’s massive, global distribution network, which includes various wholesalers, bars, grocery stores, and duty-free shops.

 

Replicating this network, which reaches more than 150 countries worldwide, would likely take competitors decades of time and cost millions of dollars of expenses. When Brown-Forman launches a new product, it can plug it into its distribution system to get it on the shelves quickly.

 

Thanks to the iconic nature of Brown-Forman’s brands, the company enjoys premium shelf space, as well as strong pricing power, which allows it to generate strong margins and returns on shareholder capital that have proven to be highly stable over time.

 

 

In fact, thanks to management’s recent decision to sell underperforming businesses, such as Southern Comfort and Tuaca, and instead focus on higher margin and faster growing brands such as Slane Castle Irish Whiskey and BenRiach single-malt scotch, Brown-Forman enjoys some of the highest profitability in an already high margin industry.

 

That’s despite being a very small company in absolute terms, especially compared to mega-rivals such as Diageo (DEO) and Constellation Brands (STZ).

 

 

Best of all, because of the company’s wide distribution and marketing reach, Brown-Forman is able to achieve solid organic growth through the launching of new product lines, such as flavored whiskeys, or even break into new markets, such as its immense success with Woodford Reserve Bourbon.

 

 

Meanwhile, Brown-Forman has been very successful in expanding its namesake Jack Daniel’s family of products to increase its reach to different price points. For example, in 1985 there were just two Jack Daniel’s brands, and today there are eight.

 

And the company continues to innovate and test new product lines, such as:

• Jack Daniels American Serve, a half size, 10 oz canned product launched in Australia that management describes as “a little bit of mixer and a lot of Jack,” with early signs being “quite promising.”
• In the spring of 2017, the company began testing Jack Daniels Cider in the U.K.
• In the fall of 2017, the Brown-Forman plans to introduce Jack Daniels Tennessee Rye nationwide.

 

While Jack Daniels is a well-known global product (it’s the 4th largest spirit brand in the world), management is confident that there is still plenty of growth opportunity left overseas since its international whiskey market share is just 3%.

 

 

In fact, the entire spirits industry is highly fragmented and ripe for consolidation. For example, the top 10 wine and spirit makers enjoyed less than 20% global market share by volume, indicating that Jack Daniels has plenty of room for market share growth.

 

And despite Brown-Forman’s success in the past five years (6% volume growth vs industry growth of 4%), thanks to its well-executed expansion of its product lines and continued push into faster growing emerging markets, the company believes that it can achieve 3% to 5% volume growth in its key brands over the next decade.

 

Overall, Brown-Forman has the strongest American whiskey brand in the world and has done an excellent job building its brand equity and converting it into growth for many decades.

 

With a continued focus on advertising, new product introductions, and deeper penetration in international markets, Brown-Forman has plenty of opportunity to continue taking share in the fragmented spirits market and delivering on its volume growth targets.

 

Key Risks

There are several risks to consider with Brown-Forman.

 

First, consumer tastes can unexpectedly evolve over time, which can help or hurt demand for Brown-Forman’s products.

 

The surge in whiskey sales has certainly served as a driving force behind Brown-Forman’s business over the last five years, but it’s less clear how the next five years will play out. There is risk that the rate of growth slows more than the market expects.

 

Consumer trends are simply unpredictable. According to Brown-Forman’s 2015 annual report, American whiskey was a declining category from 1970 to 2010 as consumer tastes moved toward white spirits, for example.

 

Where demand goes from here is anyone’s best guess, but Brown-Forman’s business is concentrated in a single product category, which creates risk if consumer tastes unexpectedly shift.

 

Additionally, keep in mind that, while generally considered a defensive industry (i.e. recession resistant), the spirits industry is generally a slow growing one.

 

In fact, between 2004 and 2009, the industry’s 3.6% annual growth rate was considered a boom time, especially compared to the 0.6% annual growth rate expected from 2014 through 2020.

 

This explains why we’ve recently seen so many large scale acquisitions in the industry in recent years, including many that appear to be overvalued, such as Pernod buying Vin & Sprit, the makers of Absolut Vodka, for $8.9 billion in 2008, or 2014’s purchase by Suntory of Jim Beam and Maker’s Mark for $13.6 billion.

 

While there may not be many mega-mergers left in the spirits industry (few companies are big enough to buy fellow blue chips outright), we’re now seeing a rash of merger mania in the smaller, craft distilleries, which is where Brown-Forman has traditionally looked for its acquisition growth.

 

The problem with acquiring small craft distillers (whose fast growth has seen their market share grow from 1.1% to 2010 to 3% in 2015) is growth-starved industry giants are often willing to pay absurd valuations for what they hope to be the next mega-brand in the making.

 

However, according to a leading industry study, 91.7% of America’s 1,300 craft distillers sell 5,278 cases a year or less, and industry experts estimate that 80% have annual sales of $1 million or less. This means that it can become very easy to massively overpay for a growth runway that could end up being far shorter than an acquirer hopes.

 

For example, in 2016 Constellation Brands purchased High West Distillery, a Utah-based craft distiller that sells just 70,000 9 liter cases a year, for $160 million or $2,285 per case.

 

Meanwhile, Diageo recently agreed to purchase Casamigos, a super premium Tequila brand co-founded by George Clooney, for up to $1 billion, paying what some analysts believe is 20 times sales and $5,882 per annual case, a mind boggling sum in an industry where four to six times annual sales or $1,000 per annual case is the norm for acquisitions.

 

Or to put it another way, shareholders have to trust management to avoid overpaying for craft brands in the name of growth, which isn’t easy given that studies indicate that close to 90% of mergers and acquisitions end up reducing shareholder value.

 

Another risk is political and regulatory in nature. Remember that Brown-Forman operates in over 165 countries, and thousands of smaller state, county, and local jurisdictions, many of which use excise (sin taxes) to raise revenue (theoretically also to reduce problem drinking).

 

As you can see, alcohol excise taxes are very high and can be highly volatile over time.

 

 

Now Brown-Forman has adapted to a world of high alcohol taxes, but there is always the risk that in the future, cash-strapped local and state governments, perhaps desperate to make up their public pension shortfalls, start hiking all manner of taxes.

 

Excise taxes on tobacco and alcohol are generally the easiest and most popular to increase. Especially given that alcoholism is a rising problem in the U.S. (a recent study indicates that 1 in 8 Americans are problem drinkers), which may provide tax-hungry politicians cover to raise alcohol taxes in the name of improving public health.

 

Then of course there’s the fact that because so much of Brown-Forman’s business is overseas, its sales, earnings, and cash flow will face meaningful currency risk over time. Specifically that means a strong U.S. dollar could generate significant growth headwinds in an already highly mature (i.e. slow growing) industry.

 

Speaking of international growth, be aware that Mexico is one of Brown-Forman’s most important growth markets, with sales in that country recently growing a very strong 18%.

 

However, the U.S. is now renegotiating NAFTA, and President Trump has indicated that he expects the U.S. will eventually pull out of this agreement, which could result in high tariffs on its products and thus reduce this growth significantly.

 

Finally, be aware that investing in Brown-Forman means accepting the decisions of the ruling Brown family, which is made up of about 40 descendants that own about 70% of the class A stock (which have all the voting rights).

 

While the family has done a good job of allowing the board of directors and management to grow the company over time, you need to realize that the Brown family has stated that they will never allow the company to be acquired.

 

In fact, in 2017 Constellation Brands made an unsolicited offer to acquire the company, for what would have been likely been at least $22 billion, or a likely 10% to 20% premium to the current market cap. The offer was rebuffed by Brown-Forman because the Brown family desires it remain independent.

 

While that could be viewed as a positive (it is a legendary dividend aristocrat after all and so it would be a shame if it were acquired), shareholders need to realize that owning this stock means you have effectively no control over what management does.

 

Overall, as long as the American whiskey category continues to see growth and Brown-Forman continues investing in its Jack Daniel’s brand, it’s hard to find many fundamental risks with the business.

 

Brown-Forman’s Dividend Safety

We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend.

 

Our Dividend Safety Score answers the question, “Is the current dividend payment safe?” We look at some of the most important financial factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more.

 

Dividend Safety Scores range from 0 to 100, and conservative dividend investors should stick with firms that score at least 60. Since tracking the data, companies cutting their dividends had an average Dividend Safety Score below 20 at the time of their dividend reduction announcements.

 

 

We wrote a detailed analysis reviewing how Dividend Safety Scores are calculated, what their real-time track record has been, and how to use them for your portfolio here.

 

Brown-Forman has a Dividend Safety Score of 96, indicating that its payout is among Wall Street’s most secure and dependable. That’s to be expected for a dividend aristocrat that has been raising its annual dividends every year since 1985 and paying a regular quarterly dividend for 72 consecutive years.

 

 

The key to this incredible dividend safety and growth consistency is twofold. The first is that management has taken a disciplined approach to maintaining a moderate and safe free cash flow payout ratio.

 

The company’s score is helped by its relatively low free cash flow payout ratio, which sits at 52% over the last four quarters.

 

Brown-Forman’s reliable cash flow generation provides enough of a safety cushion that even during bad years the company’s payout remains highly secure and capable of growth.

 

 

Brown-Forman’s healthy payout ratio looks even better when you consider that the alcoholic beverage market is very stable in nature. The company’s sales fell by just 4% and earnings actually grew during the financial crisis, highlighting the non-discretionary nature of whiskey (consumers have a craving for whiskey whether times are good or bad).

 

The second major protective factor is the strong balance sheet, a major advantage in a highly capital intensive industry that requires lots of specialized equipment.

 

 

While Brown-Forman does have a lot of debt on an absolute basis, it also generates a large amount of free cash flow, which combined with its very high current ratio (short-term assets/short-term liabilities) indicates it has no trouble servicing its debt or keeping the business running.

 

When we compare these relative debt metrics to its industry peers, we truly get a sense of how strong Brown-Forman is financially.

 

 

For example, Brown-Forman’s leverage ratio (Debt/EBITDA) is not just much lower than the industry average, but its current ratio is much higher, and its very high interest coverage ratio explains why it has such a strong investment-grade credit rating.

 

That in turn allows it to borrow very cheaply (average interest rate 2.75%) and provides it with the financial flexibility to continue investing in the growth of the company while rewarding dividend investors with the fast and steady payout growth they have come to expect.

 

Brown-Forman’s Dividend Growth

Our Dividend Growth Score answers the question, “How fast is the dividend likely to grow?” It considers many of the same fundamental factors as the Safety Score but places more weight on growth-centric metrics like sales and earnings growth and payout ratios. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.

 

Brown-Forman has a Dividend Growth Score of 83 indicating that dividend investors can likely expect better than average payout growth in the years and decades to come.

 

 

With Brown-Forman’s current FCF payout ratio at a moderate 52%, investors should expect the company’s dividend to grow about in line with its earnings and FCF/share.

 

Fortunately, the company’s continued expansion into new products and faster growing markets means that it should be able to leverage 4% long-term sales growth into 7% to 9% EPS and FCF per share growth thanks to ongoing margin expansion (larger economies of scale and higher margin product mix) and 1% to 2% annual share buybacks.

 

That, in turn, should allow Brown-Forman to continue growing its dividend by 7% to 9% a year going forward, similar to its historical norms.

 

Valuation

Over the past year, Brown-Forman’s stock has performed about in line with the S&P 500, returning approximately 18%. Unfortunately, today does not appear to be the best time to consider buying the stock.

 

For example, Brown-Forman’s forward P/E ratio of 28.5 is far higher than the S&P 500’s forward PE of 17.4, as well as the industry median of 22.9 and the stock’s own historic norm of 21.6.

 

Meanwhile, the stock’s dividend yield is currently a paltry 1.3%, significantly below the S&P 500’s 1.9% (though greater than the industry median of 0.8%).

 

Now keep in mind that Brown-Forman’s 13-year median yield is 1.7%, indicating that even at fair value it may not be appropriate for those looking to live off dividends during retirement.

 

However, at today’s seemingly frothy valuation levels, investors interested in Brown-Forman are probably better off waiting for a correction before opening or adding to their positions.

 

That’s because at today’s price, long-term investors have potential to generate annual total returns between 8.3% to 10.3% (1.3% yield + 7% to 9% annual earnings growth).

 

However, that assumes everything goes well and the stock’s lofty valuation multiple remains steady, which is far from a guarantee.

 

More likely, the strong rise in demand for bourbon and increased M&A speculation in recent years have caused the market to raise its expectations for Brown-Forman.

 

Given the valuation risk, I feel more comfortable remaining on the sidelines.

 

Conclusion

Brown-Forman, thanks to its strong portfolio of iconic brands, wide moat, long international runway, and high margin business overseen by a disciplined management team, has all the makings of a future dividend king.

 

While the company’s growth rate isn’t likely to ever make headlines, Brown-Forman could be an interesting dividend growth investment to consider at the right price. For now, it’s hard to get comfortable with the stock’s valuation, but it’s worth a spot on the watch list.