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Is Brown-Forman Stock a Buy?

By Will Healy – Jun 16, 2020 at 9:50AM

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Brown-Forman brings both stability and a high valuation.

The COVID-19 pandemic has brought more attention to consumer staples stocks such as Brown-Forman (BF.A 0.49%) (BF.B 0.42%), as prolonged lockdowns led to a massive surge in off-premise alcohol sales.

Unfortunately, increased home consumption did not fully compensate for the lost business from bars and restaurants. Consequently, the maker of brands such as Jack Daniel's whiskey, Herradura tequila, and Finlandia vodka saw its stock fall along with the general market in February and March.

Brown-Forman stock recovered some of its losses beginning in mid-March, so investors have already missed the opportunity to buy at a low. Now, investors must consider whether Brown-Forman is still a worthwhile investment at a higher price.

A shares vs. B shares

Brown-Forman is really two different stocks. The A shares carry with them voting rights, while the B shares do not. However, the B shares trade at a premium to the A shares. The reason is liquidity. On average, only about 52,700 A shares trade per day. Every buyer must find a seller, and buyers can find them more easily in an environment of high liquidity.

Hence, the large, institutional traders prefer to buy the B shares. Here, investors trade an average of around 1.3 million shares each day, making it easier to handle large positions. Since most small investors are better off buying the lower-cost A shares with voting rights, the metrics below will pertain to the A shares. 

Brown-Forman avoided disaster during the pandemic

Both share types rose modestly following the recent earnings release. The company revealed that sales dropped by about 5%. This led to net income falling by around 20%.

Whiskey pouring into a glass.

Image source: Getty Images.

However, even amid the shutdowns, there were some bright spots in the company's sales numbers. Underlying sales -- a metric that strips out currency fluctuations and changes in distributor inventories -- of Woodford Reserve increased by 17%, leading to a 21% surge in the premium bourbons category. Also, Gentleman Jack and Herradura each saw underlying sales increase by 7%. Still, for the majority of products, sales decelerated compared to the previous quarter, which ended in January. 

Investors had anticipated falling sales and sold Brown-Forman stock early in the year. Fortunately, the stock has recovered most of the losses from the selling in February and March. Nonetheless, it trades about 13% below its 52-week high. Over the last few years, Brown-Forman stock has established a history of slow but steady moves higher and has risen by nearly 44% over the past five years.

BF.A Chart

Brown-Forman Stock Performance, data by YCharts.

Watch the valuation

This share-price appreciation has left the company with a relatively high valuation. The forward P/E ratio now stands at 35.1. Brown-Forman's earnings may not back up such a multiple. Analysts expect earnings per share to fall by 3.5% in fiscal 2021 before increasing 12% in the following year.

Although Brown-Forman's business remains stable, the company has no apparent growth catalysts. Making matters worse, the annual dividend payout of just under $0.70 per share yields about 1.1%.

The company sometimes pays special dividends like the $1 per share payout it distributed in 2018. Brown-Forman has also increased its quarterly payout for 36 consecutive years. Still, even when considering special dividends, long term, the yield falls short of the S&P 500 average of just under 2%.

Over the next five years, analysts expect only about 0.8% annual profit growth on average. Admittedly, a lot can change in five years. Still, that level of growth makes the P/E ratio difficult to justify.

Should Brown-Forman seek new growth areas?

Brown-Forman's recent earnings report acknowledged some of the problems that could limit future growth. Some competitors have turned to new product lines or alternative industries in response. For example, Molson Coors has added small breweries to its portfolio. Constellation Brands, a more direct peer, drew significant attention with its massive investment in Canadian cannabis giant Canopy Growth.

However, neither Brown-Forman nor Constellation can buy out every small distillery. Moreover, Constellation's investment in Canopy has, so far, lost money. While Brown-Forman and its industry in general must accelerate growth, it remains unclear where they will find new sources of revenue.

The financials show continued stability for the company. However, until investors can buy at a lower multiple or Brown-Forman is able to find new sources of income, I see little reason to purchase this stock.

Will Healy has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Constellation Brands. The Motley Fool has a disclosure policy.

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Brown-Forman Corporation Stock Quote
Brown-Forman Corporation
$68.85 (0.42%) $0.29
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Brown-Forman Corporation
$69.66 (0.49%) $0.34

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