Published by Bob Ciura on November 7th, 2017
The Dividend Aristocrats are a group of 51 companies in the S&P 500 Index, with 25+ consecutive years of dividend increases.
Each year, we review all 51 Dividend Aristocrats. The next stock in the series is alcoholic beverages manufacturer Brown-Forman (BF-B).
Brown-Forman has paid a dividend for 71 years, and it has increased its dividend for 33 years in a row.
It has maintained its dividend growth streak thanks to a strong brand portfolio.
Brown-Forman is one of a group of companies commonly referred to as ‘sin’ stocks. These are companies in the alcohol, tobacco, and gaming industries.
This article will discuss Brown-Forman’s business model and growth prospects, and whether the stock is still undervalued today.
Business Overview
Jack Daniel’s Tennessee Whiskey got its start all the way back in 1865, when Jack Daniel purchased Cave Spring Hollow. The following year, he registered the Jack Daniel Distillery, which stands today as America’s oldest registered distillery.
Brown-Forman has a large product portfolio, which is focused on whiskey, vodka, and tequila. Its most famous brand is its flagship Jack Daniel’s whiskey. Other popular brands include Herradura and El Jimador tequila, and Finlandia vodka.
At the same time, these have been some of the most rewarding stocks to own over the long term. The reason is because ‘sin’ stocks tend to sell addicting products or services.
Brown-Forman generates high operating profit margins, and has expanded its margins in recent years.
Source: Annual Stockholder Meeting, page 11
Last year, organic sales increased 3% from the previous year. Cost controls and share repurchases fueled 7% operating profit growth. Adjusted earnings-per-share increased 5% for the year, to $1.71.
The strongest-performing products last year were Jack Daniel’s Tennessee Fire (up 14%), Woodford Reserve (up 19%), and Herradura (up 14%).
The company saw strong results both in developed, and under-developed markets. Net sales increased 4% in the U.S. and the emerging markets last year.
Next year and beyond, Brown-Forman will continue to benefit from its leading brand portfolio, with growth in new products and geographic markets.
Growth Prospects
Brown-Forman has continued to grow in the current fiscal year, and should maintain positive earnings growth over the long-term.
Overall, revenue increased 9.4% last quarter, and beat analyst expectations by $33 million. Earnings-per-share also came in above expectations, and rose by 27% from the same quarter last year.
Emerging-market sales increased 19% last quarter. Brown-Forman’s international performance was strong last quarter, especially in Mexico, Australia, and in Eastern Europe.
Source: Q1 Earnings Presentation, page 7
The company’s strongest growth categories are its smaller brands, particularly in the premium whiskey segment. Collectively, its high-end whiskey brands posted double-digit revenue growth last quarter, led by Woodford Reserve, which was up 16%.
The Jack Daniel’s family of brands posted 6% growth last quarter.
Going forward, there is plenty of growth potential left, as the company further expands its product line, both inside and outside of whiskey.
Source: Annual Stockholder Meeting, page 17
For example, two of the company’s top-performing brands last quarter were its tequila brands Herradura and el Jimador, which grew revenue by 18% and 13%, respectively.
For the full year, Brown-Forman expects net sales growth of 4%-5%, led by its premium American whiskey and tequila brands. Operating profit is expected to increase by 6%-8%, thanks to sales growth and share repurchases.
Competitive Advantages & Recession Performance
Brown-Forman has many competitive advantages. Its popular brands yield significant pricing power. And, it has a highly profitable business, with low manufacturing and distribution costs because of its global scale.
These qualities help Brown-Forman generate consistently high returns on invested capital. Return on capital exceeded 15% return on capital each year since 2008.
Source: Annual Stockholder Meeting, page 12
An excellent global distribution network and pricing power led to 23% return on invested capital last fiscal year.
Brown-Forman is very resistant to recessions. This is typical among ‘sin’ stocks, as their products tend to be consumed in greater volume when economic times are tough.
One could argue that alcohol manufacturers actually perform better during recessions, as consumers seek out products that relieve stress.
Brown-Forman’s earnings-per-share through the Great Recession are shown below:
- 2007 earnings-per-share of $0.95
- 2008 earnings-per-share of $0.96 (1% increase)
- 2009 earnings-per-share of $1.03 (7.3% increase)
- 2010 earnings-per-share of $1.19 (15% increase)
As you can see, the company grew its earnings-per-share every year through the Great Recession. This is a rare accomplishment that demonstrates the company’s defensive business model.
Valuation & Expected Returns
Brown-Forman stock trades for a price-to-earnings ratio of 30.4. This is significantly above the S&P 500 Index, which has an average price-to-earnings ratio of 25.8.
According to ValueLine, in the past 10 years, the stock held an average price-to-earnings ratio of 22.7. As a result, the stock is currently trading at a roughly 34% premium to its 10-year average valuation.
Source: Value Line
This could indicate an overvalued stock. If Brown-Forman’s valuation multiple reverts toward its 10-year average, it would significantly impact future returns.
Aside from changes in the valuation multiple, future returns will be comprised of earnings growth and dividends.
In the past 10 years, Brown-Forman grew earnings-per-share by 6% per year. Given its accelerated growth in recent years, a potential breakdown of future returns could be as follows:
- 4%-6% organic revenue growth
- 1% margin expansion
- 1% share repurchases
- 1.3% dividend yield
Based on this, future returns would reach approximately 7%-10% per year, plus (or more likely) minus any changes in the price-to-earnings ratio.
In addition to the risk of a contracting valuation multiple, the other negative aspect of buying stocks with rising price-to-earnings ratios, is a shrinking dividend yield.
As Brown-Forman’s share price has climbed over the past several years, its dividend yield has fallen to 1.3%, which is below the 2% average yield of the S&P 500 Index.
Final Thoughts
Brown-Forman has a dominant position in its core product categories. Its flagship Jack Daniel’s brand should continue to lead the whiskey industry, with high growth from its smaller whiskey brands and tequila.
Brown-Forman is a good example of a great business trading at an unattractive valuation. It would make a great buy… At a reasonable price-to-earnings ratio. As a result, investors should wait for a better entry point before buying shares of this high-quality dividend growth stock.
