Brown Foreman Case

Brown-Forman

Company Overview, Industry, and Products

Brown-Forman is one the largest manufacturers of wine and spirits in the United States. The company was founded in 1870 by George Garvin Brown, with the Brown family still owning more than 70% of voting shares. Brown-Forman currently markets around 30 brands in over 135 countries with the US representing 42% of fiscal 2012 sales, Europe 27%, and the rest of the world 31%. Some of the company's well-known brands include Jack Daniels (52% of 9-liter cases sold in fiscal 2012), Finlandia Vodka (9% of cases), Southern Comfort (7% of cases), and Canadian Mist (5% of cases).

Over the past five years Brown-Forman has grown revenues roughly in-line with the industry at an annualized rate of 5.2%. The stock has been one of the best performing in the Student Managed Investment Fund with a price appreciation of over 41% since originally pitched in October 2011. The company has an excellent record of returning shareholder value and has increased its dividend payments at an annualized rate of 7.52% over the last five years. The company is currently paying out 36% of earnings as dividends, which I believe can increase to industry averages of 40% or higher. Return on equity of 25.88% and return on assets of 14.8% remain above industry averages.

The wine and spirit industry is in the mature stage of the product life cycle in developed markets as revenue growth is for the most part saturated, moving roughly with GDP and inflation. However, with populations and income in the developing nations rising, growth has increased rapidly in these markets. Brown-Forman's emerging markets sales grew by 17% in 2012 contributing to 45% of total net sales growth, and now accounts for 25% of the company's revenues.

Branding is critical for success in the industry and Brown-Forman's Jack Daniel's brand is one of the most recognized whiskeys across the World. If the company is able to successfully promote and improve brand loyalty it will garner a larger market share. Jack Daniels branding superiority was witnessed during the 2011 introduction of Jack Daniel's Tennessee Honey, which in its first 4-months sold more than the combined 4-month sales of Evan Williams Honey, Wild Turkey American Honey, and Red Stag. Whiskey remains the highest margin spirit, which provides a competitive advantage to Brown-Forman as taste for western style beverages increases in emerging markets.

Competitors and Environment

Brown-Forman's key competitors include Diageo (10% of market share), Pernod Richard (4.6% of market share), Bacardi Limited, Constellation Brands, Beam, and Fortune Brands, which collectively represent less than 5% of total market share. The company holds a 72% share of the flavored brown spirits market in the US, but only represents 1.6% of the global wine and spirits sales.

The industry is relatively fragmented and according to International Wine & Spirit Research, in 2011, the ten largest global spirits companies controlled only about 20% of the total global market for spirits. However, over the last two decades, there has been a trend towards consolidation, as medium-size and large corporations are merging and heavily marketing products to increase volume sales and enhance brand reputation in growth markets. As a result, smaller producers face intensified competition, resulting in either industry exit or consolidation. IBIS predicts that the number of spirit producers to decline at an annualized 10-year rate of 2.7% to 13,139 in 2017. Consolidation is expected to enable companies to increase industry net margins to 9.4% in 2017, from 9.0% in 2012, and make it easier for companies to pass on rising commodity prices to consumers. This trend will be particularly prevalent in emerging markets, as the spirit markets in these countries are dominated by domestic manufacturers and high tariffs protect against foreign entrance. For example, in India domestically produced whiskey represents over 98% of sales, largely due to taste preferences and tariffs of imported spirits at up to 550%.

Barriers to entry are somewhat high, as result of high capital requirements, long production times and government regulation. Building and maintaining a brand is a highly capital intensive process, and larger producers have a significant cost advantage over smaller producers, and can channel cash flows into advertising, and enforcing trademarks. Typically bourbon and Tennessee whiskeys must be aged for at least two years, with Brown-Forman aging their whiskeys between three and six years. A well-established company will be able to better handle the long time between product creation and revenue recognition. In many countries to sell or produce alcohol the company must first obtain for a license before they are legally allowed to do so, which can be a long and expensive process.

Going Forward- What I like

Economic growth in developed nations continues to remain sluggish since the recent recession. As a defensive product, alcohol sales should fare better than discretionary goods if the economy or wages weaken. Many investors remain uncertain of the fate of the Eurozone and the outcome of the 1.2 billion dollars in automatic