Fortune Brands (NYSE: FO ) is probably best-known for its alcohol-related products, such as Jim Beam, but since the company sells faucets, doors, and golf balls, among other items, I think of it as a conglomerate. Shhhh... that's a dirty word in many circles, and Fortune may not like to hear it from me, but conglomerates aren't necessarily bad, even if the word carries a negative stigma.
I find the alcoholic-beverages side of Fortune to be the most attractive, but if it weren't for things like doors and faucets, Fortune might not have turned in another quarter of 10% earnings growth. The reason: The spirits business was flat, and those flat results were aided by a partnership with Starbucks (Nasdaq: SBUX ) to produce a new coffee liqueur, which the company says is selling quite well.
Traditionally, Fortune has generated a ton of free cash flow. The firm uses much of that cash flow to do some of the shareholder-friendly things that I, as a value investor, adore, like buying back shares and paying out a rising dividend. According to Fortune's earnings release, this year will be no different. However, I'm not entirely comfortable with the buybacks, given the size of the company's debt load. Currently, the debt is manageable, and if Fortune wished, it could pay it all off in a few years with its robust free cash flow.
But the debt looms as a potential problem because of a pending acquisition: The company is teaming up with Pernod Ricard for parts of Allied Domecq (NYSE: AED ) . As my Foolish colleague Rich Duprey mentioned recently, Standard & Poor's is already thinking about downgrading Fortune's debt if the company takes on more to fund the acquisition.
If the acquisition goes through and Fortune purchases substantial pieces of Allied Domecq, I think it is likely that future dividend increases will be smaller, or stock buybacks will be scaled back, or possibly both, in order to fund not only the increased size of Fortune's debt, but also the increased cost of the debt.
All of this raises an interesting point. The common wisdom is that this acquisition puts the heat on industry titan and Income Investor recommendation Diageo (NYSE: DEO ) . I disagree. The acquisition gives Fortune size, but Diageo is in a better competitive position as a result of its sound balance sheet and its disposal of non-beverage businesses to focus solely on beverages. I could be wrong, but I prefer to wait this one out on the sidelines and see what Fortune's capital structure looks like after the acquisition.
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Fool contributor Nathan Parmelee owns shares in Starbucks but has no financial interest in any of the other companies mentioned. The Fool has a disclosure policy.
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