Brown-Forman: A Look Back at 2012

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With only a handful of trading days left in 2012, it's a great time for investors to examine the stocks they own and decide whether their performance met expectations. Oftentimes, investors gravitate toward short-term stock performance, but it's important to study other factors -- like sales trends, changes in management, and pending litigation -- when figuring out if a company justifies a spot in their portfolios.

Today we'll take a look at liquor maker Brown-Forman (NYSE: BF-B  ) and examine its successes and challenges.

Company info
Spirits company Brown-Forman produces Jack Daniel's whiskey, Finlandia vodka, and Southern Comfort liqueur. The company derives 42% of net sales from the U.S., 27% from Europe, and 31% from the rest of the globe. Not surprisingly, Brown-Forman has its sights set on emerging markets for future growth. It's paying off: Finlandia is the No. 1 imported premium vodka brand in Russia, and Jack Daniels enjoyed a 32% growth rate in Latin America last year. Brown-Forman's stock price has increased 19% year to date, twice as much as the Dow Jones Industrial Average.

Spirited growth
To combat loss of market share in years past, Brown-Forman is banking on product innovation to reclaim share. The company was quick to enter the increasingly popular flavored brown spirits market and already possesses a foothold on the market. With its Jack Daniel's Tennessee Honey and Southern Comfort flavored brands, Brown-Forman holds a 72% market share of flavored brown spirits in the U.S. Sales of flavored whiskeys rose nearly 155% in the first quarter of this year, representing the fastest-growing spirits type in the U.S.

But other competitor brands are turning up the heat on this already-hot market, with a host of new product launches. Diageo (NYSE: DEO  ) has added a honey variation to its Bushmills whiskey brand. Meanwhile, Beam (UNKNOWN: BEAM.DL  ) rolled out its Reg Stag flavored whiskey, and Davide Campari's (NASDAQOTH: DVDCY  ) Wild Turkey American Honey is also a competitive brand in this market. All of these brands infuse flavors like black cherry, honey, and cinnamon into bourbon and are hoping to steal market share from Brown-Forman. 

Targeted toward an underserved female market, Brown-Forman's Little Black Dress Vodka was launched in the U.S. last year. The brand was well received and enjoyed case depletion within the first three months of product launch, an indicator of high demand. Beam's Skinnygirl line is a direct competitor in the female market and has achieved wild success, with 486% net sales growth from its March 2011 acquisition through the end of last year. If Little Black Dress Vodka experiences anything close to that achievement, it'll bode very well for Brown-Forman.

Isn't that special?
Brown-Forman will pay a special dividend in late December amounting to approximately $815 million and will finance this dividend mostly with newly issued debts. The newly issued $750 million notes will carry interest rates ranging between 1% and 3.75% and will roughly double the amount of long-term debt on the company's balance sheet. Excluding the new debt issuance, Brown-Forman boasts a very modest debt-to-equity ratio of 22%. 

During the last 10 years, Brown-Forman has consistently delivered double-digit return on invested capital (ROIC), in the range of 16% to 23%. In the trailing 12 months, the company's return on equity was nearly 26%. As was the case for Costco (NASDAQ: COST  ) , funding a special dividend with debt is not necessarily a poor decision. Assuming Brown-Forman is capable of continuing to earn double-digit ROIC, it's arguably better for the company to use cash in its operations. For companies with strong balance sheets like Costco and Brown-Forman, issuing inexpensive debt to pay dividends may be a prudent move.

However, this maneuver didn't pass the sniff test for Standard & Poor's. The ratings agency downgraded Brown-Forman's debt to A-, and noted that, while its brands are well recognized, the company has a smaller portfolio than many of its global beverage counterparts. Shareholders also didn't like what they saw. After the debt-funded special dividend announcement on Nov. 27, the stock took a sizable hit and has declined nearly 8% since that date. The stock was up nearly 30% for the year through Nov. 27. 

Foolish bottom line
Undoubtedly, Brown-Forman posted a solid 2012. But will its foray into new markets pay off in 2013? Or will its stock price continue to feel the effects of its debt-rating downgrade? Time will tell.

Meanwhile, Costco's special dividend isn't all the stock has going for it -- shareholders have walloped the market, returning 11,000% over the past two decades. However, with prices near all-time highs, is the ride over for Costco investors? To answer that, we've compiled a premium research report with in-depth analysis on whether Costco is a buy right now, and why. Simply click here now to gain instant access to this valuable investor's resource.

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