How Brown-Forman Will Build on the Success of 2014

On June 4, Brown-Forman (NYSE: BF-B  ) investors got to take a look into the results of the company's operations for fiscal 2014, and they have plenty to be excited about.

Some of the highlights for 2014 include:

  • Reported sales growth of 4%, 6% underlying (ignoring currency effects and non-recurring items)
  • Reported operating income growth of 8%, 11% underlying
  • Earnings and earnings-per-share growth of 11%
  • Increased regular cash dividend by 11%

Now we can dig into the report and see how and why the company reported such strong numbers and how it can continue to do so even with stiff competition from Diageo  (NYSE: DEO  ) and Constellation Brands (NYSE: STZ  ) .

The sales growth
Brown-Forman grew sales by 4%, which is right in line with the previous 10-year compounded annual growth rate of 4%. This sales charge was led by its American whiskey category, which mainly consists of the Jack Daniel's brands. Underlying net sales for the Jack Daniel's brands grew by 8% in fiscal 2014.

A quick peek into the future suggests that the company can keep up this pace. It has new product lines which are growing very quickly such as Jack Daniel's Tennessee Honey and it is also growing sales at an exceptional pace in certain international markets.

A large reason I believe Brown-Forman will continue its growth is its international presence. The company's top three countries by sales, the United States, Australia, and the United Kingdom, made up 63% of sales in 2014, and the top ten represented 84% of sales. Its underlying sales growth in the top three countries was only 2.7%.

With 84% of the company's sales coming from only ten countries, this leaves just 16% to the rest of the world. Investors should love to hear this, as 16% of the company's underlying sales grew by 15% and plenty of room remains for more. 

The earnings growth
Brown-Forman's earnings growth has been helped along by widened margins over the last several years. Net profit margin this year stood at 15.6%, as it has grown steadily over the last ten years from 10% in 2004.

Brown-Forman's excellent position as one of the largest companies in a business-friendly competitive environment has helped margins grow and will continue to do so in the future.

Brown-Forman enjoys a lack of pricing pressure from suppliers, as the biggest inputs for whiskey are corn and water, which are commodities. It also doesn't face pricing pressure from buyers because its products are known for excellence and consumers are loyal to its brands. Most customers are willing to pay the extra few dollars to get their favorite middle-shelf whiskey over bottom-shelf competitors.

There are threats of substitutes such as consumers switching to wine or beer, but as said earlier, most consumers are fairly loyal to their favorite drinks and brands. Lastly, barriers of entry are high for new competitors due to the large investment required to create a large-scale distillery and the laws and regulations involved.

The dividend
Brown-Forman once again raised its dividend payout, as it has for 30 years running, to $1.09 per share. The cash dividend rose 11% over the cash dividend in 2013, excluding the special dividend issued that year. This is now the 68th consecutive year in which the company has paid a dividend, and the yield currently stands at 1.6%.

I believe the company is committed to paying plenty of cash to its shareholders and has the financial means to continue to do so in the future. In 2014, the company's free cash flow to equity covered the dividend 2.25 times. The dividend coverage by free cash flow to equity is below the five-year average of 4.7, but investors shouldn't be alarmed as this is mainly due to the company paying off debt this year. 

Sizing up the competition
Two of Brown-Forman's largest competitors are the spirits giant Diageo as well as a smaller, more diversified Constellation Brands.

Diageo has outpaced Brown-Forman in sales growth over the last ten years but has fallen short in earnings growth, only growing earnings by 6% per year compared to Brown-Forman's 8% growth per year.  

For Constellation Brands, which is more diversified into other alcoholic beverages such as beer and wine, growth is another story. The company's revenues and earnings have been very volatile over the last ten years, but largely unchanged other than this last year which had debt-fueled growth by acquisition.

I believe Brown-Forman will outpace these two competitors due to the surging popularity of American whiskey worldwide, as well as the company's continued efforts in emerging markets.

Diageo, who competes with Brown-Forman primarily with their Scotch whisky, already relies on 42% of their sales from emerging markets and these regions only grew sales at 11% in 2013, growth which was partially fueled by acquisitions.  Constellation Brands competes with Brown-Forman on a basis of substitute products as they sell primarily beer and wine, but the company has barely touched emerging markets yet. Constellation derives 89% of its sales from the United States and 11% from Canada, New Zealand, and Italy.

I believe the growth already shown by Brown-Forman and expected growth justifies its shares trading at 25 times forward earnings compared to both Diageo and Constellation trading at around 18 times forward earnings.

A Fool's take
Brown-Forman put up very strong numbers in 2014, and in its report the company proudly stated that its compounded annual total shareholder return (assuming dividend reinvestment) has been 17% over the last ten years, more than double that of the S&P 500.

I believe the company could easily continue this trend as it is in a favorable competitive environment and it continues to expand its products into emerging markets. 

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