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Brown-Forman (BF.B) Offers a Balanced Risk-Reward Right Now

Zacks Equity Research

Brown-Forman Corp. BF.B remained on growth trajectory throughout 2019 on the back of strong brand portfolio, given robust momentum in premium bourbons and tequilas. Additionally, investments to strengthen Jack Daniel's family of brands have been aiding its performance. Notably, Jack Daniel's Tennessee Whiskey has been the key contributor of growth in the United States for more than a decade.

Furthermore, the company is confident of capitalizing on the American Whiskey strategy, with continued benefits from investments in the brand portfolio. These factors have collectively contributed to strong quarterly outcomes for the company, also leading to a solid share price trend. The stock has gained 42.5% in the past year, outpacing the industry’s growth of 17.9%.



However, Brown-Forman has been witnessing headwinds related to tariffs imposed on American spirits, which have been hurting underlying sales and margins since the first quarter of fiscal 2019. This along with higher input costs are hurting its gross margin, which should persist throughout fiscal 2020.

With these lingering headwinds, let’s see how this Louisville, KY-based alcoholic beverages company will retain stock momentum.

Factors Favoring the Stock

Brown-Forman’s strong portfolio of globally-recognized brands, including the Jack Daniels family of brands, positions it well in the alcohol beverage space. It currently owns and produces a multitude of popular spirit brands, including Jack Daniels, Southern Comfort and Finlandia Vodka. We expect the company’s continued focus on pricing, product innovation and expanding operations in emerging markets to boost operational performance and further strengthen market position.

In fact, broad-based growth across Brown-Forman’s brand portfolio and geographies is primarily aiding its results. Brown-Forman’s underlying sales growth in first-half fiscal 2020 reflects notable strength in the United States, its largest market. Results in the United States were aided by premium bourbons and tequilas. Notably, underlying net sales grew 6% in the United States, 2% in developed international markets and 5% in emerging markets.

The company is focused on investing in the diversification of its brand portfolio to drive growth. The company’s investments in brands are centered on the broadening of Jack Daniel’s family of brands, while exiting weaker brands and expanding the fast-growing premium spirit categories. Further, it is increasingly investing to organically accelerate the growth of two fast-growing spirits categories, namely bourbons and tequilas. These balanced portfolio investments are supporting the company’s track record of attaining consistent growth.

Factors Hindering Growth

Though the aforementioned factors make us optimistic about the stock’s potential, there are some hurdles in its growth path. The most prominent concern is the ongoing impact of tariffs.

Notably, underlying sales in the first half of fiscal 2019 and 2020 were hurt by tariff-related buy-ins, which occurred in first-quarter fiscal 2019. Further, underlying sales for the company’s Jack Daniel’s family of brands included negative impacts of last year’s tariff-related buy-ins and related net pricing reductions. In addition to the buying effects, the cost of tariffs have been reducing margins, attributed to lower pricing in certain markets wherein it sells products to distributors and higher cost in markets wherein it imports and distributes products directly.

In the first half of fiscal 2020, gross margin declined 270 basis points, resulting in an underlying gross profit drop of 2% from the corresponding period of last year. Gross margin decline was mainly driven by tariff-related expenses and higher input costs reflecting agave and wood inflation. Further, underlying operating income declined 5% in the first half, including a 6-percentage point negative impact from tariff-related costs.

Moreover, Brown-Forman lowered its underlying operating income view for fiscal 2020, based on uncertain economic and geopolitical environments in certain emerging markets, the Travel Retail channel, as well as higher input costs. The company lowered its underlying operating income growth projection by 1 percentage point. It now anticipates 2-4% rise in underlying operating income for the fiscal year compared with 3-5% growth mentioned earlier.

Wrapping Up

The above discussion clearly shows that Brown-Forman has balanced risk-reward, with growth efforts likely to offset hurdles. Further, the Zacks Rank #3 (Hold) company’s expected long-term earnings growth rate of 7.5% speaks well of its growth potential.

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