Brown-Forman (NYSE:BF.A) (NYSE:BF.B) reported disappointing third-quarter earnings last week and took down guidance for the fourth quarter. The company admitted it has a number of headwinds to work through, from tariffs to coronavirus to customer delivery issues. Despite that, the stock is trading at a premium multiple compared to competitor Diageo (NYSE:DEO).
Is the stock a buy at these levels?
Brown-Forman's brands are on point
Brown-Forman is a manufacturer and seller of alcoholic beverages with over 40 brands, including Jack Daniels, Sonoma-Cutrer wines, and Finlandia vodka. Brown-Forman has a huge international presence, with 53% of its sales outside the United States. The fastest-growing markets are the emerging markets, including Russia and Brazil. The United Kingdom is the company's second-largest market, although sales have been declining as the company reworks its distribution operations.
The United States market remains robust as the company is benefiting from younger consumers who prefer premium brands, from craft beers to high-end bourbon. Brown-Forman's premium brands include Woodford Reserve and Old Forester, along with Herradura tequila.
2020 guidance was lowered a touch
Brown-Forman earned $1.73 a share in the fiscal year 2019. In its latest report, the company took down guidance for the rest of fiscal 2020, which ends in April. Sales growth will now be in the low single digits, as opposed to the previous forecast of 5%-7%. Operating margins will be flat-to-down on higher input costs and tariffs. The 2020 earnings per share forecast range was narrowed from $1.75-$1.85 to $1.75-$1.80. At the midpoint of that forecast, the company expects 2.6% EPS growth, which is quite the deceleration from FY 2019's nearly 17% growth. What is going on?
Falling margins and sales growth
Tariffs and higher input costs (agave and wood for barrels) have been a headache for the company. Luckily for Brown-Forman, the tough year-over-year comparisons from tariffs are almost done, and a trade deal with Europe will certainly be a massive help. Still, the two issues have chopped about 200 basis points out of forecasted gross margins. In the United Kingdom, Brown-Forman ended its partnership with Bacardi. In the meantime, sales growth in the U.K. is down 9% as the company reorganizes its distribution team. Finally, it looks like Mexico's economy is slowing. Note that the company's most recent quarter ended on Jan. 31 (before the coronavirus issue really took hold).
How will the novel coronavirus pandemic affect sales? Travel Retail (international duty-free shops) will be the first affected as people slow or stop traveling. The company is already experiencing that in Asia. Social avoidance (in other words, staying home) will be another, especially if this trend continues in the United States.
If the disease ends up depressing the global economy and consumer confidence over the longer term, that will be a secondary effect. It is still too early to predict exactly how bad the issue will be, and that uncertainty is baked into the guidance.
Valuation and voting
Brown-Forman currently trades at about 33 times expected 2020 earnings per share, which is a hefty multiple for a company experiencing low single-digit EPS growth. Competitor Diageo trades at 20 times earnings. Brown-Forman has a dual-class structure (the B shares are non-voting) which means the Brown family controls the company. Given that a vote should be worth something, Brown-Forman shouldn't trade at a premium multiple, all things being equal. Personally, I have never liked dual-class structures -- they exist for a reason, and it isn't to benefit the holder of non-voting shares.
How much will defensiveness help in this crisis?
While alcoholic beverage companies are typically thought of as defensive stocks, a downturn driven by a pandemic will hit these stocks harder than a garden-variety recession. Even in recessions, people still go out to the bar, but not if everyone is afraid of getting sick. Brown-Forman does have some venerable brands and is well-positioned for current tastes.
The coronavirus situation may end up providing an opportunity to pick up the stock at a discount. But if the outbreak accelerates in some of the faster-growing markets like Brazil or Russia, then growth will stall or shrink. If we get pandemic conditions in the U.S., all bets are off.