The company caught my eye earlier this year because despite its low profile, its historical numbers look quite good. Over the past 10 years, Brown-Forman's stock has returned an average 17.3% annually with dividends reinvested, which is within our 15.5% annual return target range. Earnings per share have increased at a 10% compounded annual clip over that same span (also within our target range -- but just barely), despite a much slower 5% compounded sales growth rate.
Also during the last 10 years, gross margins have expanded from 45.7% to 51.5%, return on average shareholders' equity has ramped up from 16.3% to 23.6%, and return on average invested capital has climbed from 14.6% to 19.8%. We're using the company's own numbers here, which saves us some number-crunching time. (In all honesty, Jeff and I have wasted most of this week planning our Halloween costumes, while Spanky the Wonder Pooch always ditches work to hang around graveyards and howl at the moon at this time of year. The upshot is that we ran short on analytical time.) Obviously, we're taking the company's word that its numbers are on the level.
Given its historical performance, what exactly does the company do? Brown-Forman's business is divided into two main product categories, wine and spirits and high-end consumer durables. Here's a sampling of some of the company's better-known brand names:
Wine and Spirits
- Jack Daniel's Tennessee Whiskey
- Southern Comfort
- Canadian Mist Canadian Whisky
- Early Times Kentucky Whisky
- Finlandia Vodkas
- Old Forester Kentucky Straight Bourbon Whisky
- Bushmills Irish Whiskey
- Glenmorangie Single Highland Malt Scotch Whiskies
- Fetzer Vineyards California Wines
- Korbel California Champagnes and Wines
- Bolla Italian Wines
- Lenox fine china, dinnerware, and crystal stemware
- Gorham crystal stemware and sterling silver flatware
- Dansk contemporary flatware and houseware
- Lenox/Kirk Stieff sterling silver flatware and pewter giftware
- Hartmann, Wings, and Crouch & Fitzgerald luggage and accessories
Looking at the company's clear and concise financial statements is actually quite fun (it's the only company I know of that has "barreled whiskey" as a major component of its inventories account). We consider the company to be primarily a beverage firm, as wine and spirits account for about 70% of total revenues in any given year. Inventories and accounts receivable make up the bulk of total assets, and both accounts have been growing at rates comparable to or slower than the historical sales growth rate over the past three years. Working capital, defined as current assets minus current liabilities, has been growing, while long-term debt has been falling and currently stands at a mere 3% of total assets.
Apparently, the manufacturing processes involved in the liquor and china businesses do not change much from year to year as operating cash flow is typically four times the size of yearly capital expenditures. That situation leaves a good deal of cash lying around, which the company has recently used to pay down debt, repurchase shares, and pay dividends. (Brown-Forman's current dividend yield is 1.91%.) Some of the free cash flow generated last year was stored away and showed up in the cash and equivalents account on the balance sheet, earning lower yields than the business itself. This situation caused return on invested capital to decline to 19.8% in fiscal 1999 (year ending April 30) from 20.4% in 1998.
As we discovered with our earlier look at International Flavors and Fragrances (NYSE: IFF), how to profitably deploy free cash flow to earn higher returns is a major consideration for many mature food and beverage companies. In order to hit our goals of double-digit earnings growth and a 15.5% annual return over the next two decades, management must be able to convince us with cold, hard numbers that they know how to deploy cash in the most productive ways possible. If they prove unable to do this, then our long-term returns as shareholders will suffer. Jeff and I may seem like sticklers on this issue, but that's only natural given the type of investors we are. We don't particularly want to be known as stubborn investors, but then again that would be preferable to making a name for ourselves as market underperformers.
Another major consideration that has kept us up at night throughout this study is how these large, mature food and beverage companies intend to grow earnings in the years ahead. In Brown-Forman's case, management plans to realize higher earnings next year and beyond by increasing marketing expenditures and penetrating new, attractive markets around the globe. Like the haunting rumblings of ghosts in the attic, that strategy sounds eerily similar to the growth plans at many of the other firms we've looked at.
Jeff will be back next week with his thoughts on Brown-Forman. (He's been spending the past few days field-testing many of the company's products, drinking gallons of Korbel champagne out of a Lenox crystal wine goblet.) Until then, have a safe and Foolish Halloween!
