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Can Brown-Forman (BF.B) Withstand Tariff-Related Perils?

Zacks Equity Research

Brown-Forman Corporation BF.B displays a solid run on the brochures, owing to its robust earnings surprise trend, strong brands portfolio and product innovation. These have driven the company’s strong run in the past year.  Notably, this Zacks Rank #3 (Hold) stock has witnessed growth of 11.5% in the past year against the industry’s decline of 3.1%.

However, the recent softness in the stock owing to the impacts of tariffs imposed on American spirits cannot be ignored. While the company’s top and bottom-line performances remain favorable, the higher tariffs have taken a toll on margins due to increased costs. Consequently, we note that Brown-Forman’s shares have underperformed the industry in the year-to-date period. It displayed 15.4% gain in the period while the industry grew 22.7%.


Further, the sheer consequences of higher tariffs are reflected in the company’s guidance for fiscal 2020, which is hurting investors’ confidence on the stock.

Detailed Picture of Tariff-Related Woes

While Brown-Forman delivered strong fourth-quarter fiscal 2019, retaliatory tariffs imposed on American spirits partly affected top and bottom lines. The company witnessed impacts of cost of tariff on underlying net sales in the fourth quarter and fiscal 2019, apart from impacts on cost of sales and gross margin. Notably, underlying net sales for the fourth quarter and fiscal 2019 witnessed negative impact of nearly one percentage point from lower net prices to distributors in certain markets to offset additional tariff-related costs.

One key reason why tariff increases are largely hurting Brown-Forman is its widespread international presence. In recent years, the company has grown footprint in international markets, which is significantly contributing to total sales. However, Brown-Forman produces most spirits in the United States, which is attracting larger exports to foreign lands.

Notably, the company’s products account for nearly 60% of the American whiskey business in Europe, resulting in large exports. Consequently, the cost of tariffs on American whiskey implemented by the European Union in response to the U.S. tariff increases is hurting Brown-Forman’s performance. Moreover, its American whiskey strategy mainly focuses on building a market for its super-premium brands, such as Gentleman Jack and Woodford Reserve in Europe. With business in Europe being a large part of the strategy, it expects the tariffs implemented by the European Union to be a hindrance for its American whiskey strategy in the near term.

Brown-Forman’s gross margin continued to be impacted by tariff-related costs in the last few quarters. Notably, the company’s gross profit declined nearly 6% to $482 million in fourth-quarter fiscal 2019 while gross margin contracted 500 basis points (bps) to 64.8%. Further, gross margin contracted 260 bps in fiscal 2019, of which decline of 160 bps was due to tariffs and most of the remaining was attributed to higher input costs, including agave and wood.

Moreover, the company expects gross margin for fiscal 2020 to be impacted by the persistence of tariffs and higher input cost-related headwinds. This is likely to result in a 200-bps decline in gross margin in fiscal 2020. The company expects impacts of tariff-related costs to persist throughout fiscal 2020 compared with seven months in fiscal 2019. Additionally, it expects higher input costs, primarily related to agave, as well as ongoing wood inflation, to be an even greater drag on the gross margin in fiscal 2020.

Other Headwinds – Adverse Currency Rates

In addition to the tariff woes, Brown-Forman’s cross-border presence exposes it to negative impacts of adverse currency rates due to the appreciation of the U.S. dollar against most of the major currencies. Notably, the company sells products in over 170 countries worldwide. In fiscal 2019, unfavorable currency rates impacted net sales by nearly 2 percentage points and operating income by 3 points. Moreover, we expect these headwinds to continue in fiscal 2020.

Wrapping Up

From the above picture, it is clear that increased tariffs are likely to be a major headwind for Brown-Forman in the near future. Nevertheless, the company’s strong brand portfolio, with multitude popular spirit brands like Jack Daniels, Southern Comfort and Finlandia Vodka, keeps it afloat in this distressing environment. In fact, we expect its continued focus on pricing, product innovation and expanding operations in emerging markets to boost its operational performance and strengthen market position.

Further, the company’s positive earnings surprise in the last eight quarters brings optimism. Notably, the company is gaining from sustained sales growth in its portfolio of premium spirit brands, particularly bourbon and tequila. Additionally, international expansion for the Jack Daniel’s trademark remains a major contributor to sales growth.

Looking ahead, the company remains confident that it will capitalize on its American Whiskey strategy while benefiting from investments in its brands’ portfolio over the years. Amid tariff-related woes, these positives can keep Brown-Forman going.

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