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Brown-Forman: A Well-Moated Business Riding the Global Megatrend of Premiumization

GuruFocus.com

Tennessee-based Brown-Forman (BF.A) (BF.B) produces and markets high-quality consumer alcohol beverages, including whiskey, tequila, vodka, liqueur, wine and ready-to-drink products. The company claims to be the largest American-owned spirits and wine business. The spirit category accounts for almost 95% of the company's fiscal 2019 sales, with the most substantial contribution from whiskey products (79%).


Brown-Forman is well known for whiskey expertise through its iconic Jack Daniel's family of brands, as well as other top-notched brands such as Woodford Reserve and Old Forester. Interbrand frequently ranks Jack Daniel's as one of the top 100 global brands and the most valuable premium alcohol brand, preceding Johnnie Walker, a brand owned by Diageo (LSE:DGE). Overall, the company owns a portfolio of many of the most historic brand names in the U.S. Jack Daniel's, Old Forester, Herradura and Early Times have been around for more than a century now.

As shown in the chart below, Brown-Forman consistently delivered above-average returns on capital compared with peers such as Diageo, Pernod Ricard (XPAR:RI), Remy Cointreau (XPAR:RCO) and Davide Campari-Milano (MIL:CPR). This implies the management's skillful capital allocation and the existence of a wide moat.

Checking the geographic breakdown of the company's sales, we see a roughly one-to-one split between the U.S. and the international markets, compared with a one-to-two split at Diageo. We expect the trend premiumization to continue to play out with an emphasis on the emerging markets, where a rapidly-expanding middle class is looking to drive better instead of drinking more.

We applaud the management's focus on organic innovation with a low priority for acquisitions. Relevant line extension has proven to have meaningfully contributed to business growth. Some examples include the successful launches of Jack Daniel's Honey in 2011, Fire in 2015, Rye in 2017 and Apple in 2019.

Brown-Forman is controlled largely by the Brown family, which holds over 50% of all voting rights. Under such a structure, minority shareholder interests may not be aligned well in general. At the same time, we notice aggregate ownership of 6% among individual insiders.

Macro-economic condition is another moderate risk factor for the company, in our view. Either revenue or operating income was impacted to some extent during the past three recessions (see below).

During an economic downturn, we may see the unfavorable trends of beverage alcohol consumers trading down to lower-priced brands, which could hurt the performance of many of Brown-Forman's brands in the short term. In its 2009 annual report, the management stated:


"Not surprisingly, the global economic crisis has curtailed consumption of premium spirits brands in a number of ways. In the U.S. and the UK, we have seen less activity in on-premise accounts such as bars, pubs, and restaurants as consumers have shifted to more at-home consumption and dining. We have also seen evidence of consumers trading down from super-premium and premium brands to popular and value-priced brands. We have seen the switch to at-home consumption and trading down in some other international markets. "



While the recession risk is inevitable from time to time, shareholders may want to beware that macro-economic challenges often indirectly help the market leader in the long run by squeezing out weaker competitors.

Disclosure: The mention of any security in this article does not constitute an investment recommendation. Investors should always conduct careful analysis themselves or consult with their investment advisors before acting in the stock market. We do not own any security mentioned in the article.

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This article first appeared on GuruFocus.