Companies that sell premium spirits have fared well over the last decade. Shareholders of both Brown-Forman (BF.B -0.85%) and Diageo (DEO -0.06%) have seen excellent results over the last ten years in comparison with the market.
The distillery industry
The first thing to address is the nature of the industry in which these companies operate. Alcohol is in no way a necessity, but it is a product that sells through good times and bad. Along with this, the distilling business has somewhat high barriers to entry. Distilleries are different from breweries in that breweries face competition from thousands of craft breweries in local communities and even home brewers testing their own recipes. However, due to safety, legality, and difficulty, home distilling is far less common.
Also, there is brand loyalty. Even though there are thousands of liquor brands that come in bottles of different sizes, shapes, and price ranges, people typically buy the same brands over and over again. Whether you buy brands for their exceptional tastes or their prices, you are somewhat loyal to your brands.
These favorable business conditions lead to higher margins; both Brown-Forman and Diageo have almost identical 10-year average profit margins of over 17% . Brown-Forman and Diageo have also averaged returns on equity of 26% and 36%, respectively, over the last ten years.
More to love
Another reason these companies have performed so well is their brand diversity. Both own premium brands that appeal to refined palates as well as lower-price brands which are favored by college students everywhere.
Brown-Forman, largely a bourbon maker, sells Woodford Reserve, a premium bourbon brand, Jack Daniels, a more moderately priced brand, and over 30 other brands of whiskey, tequila, vodka, and more.
Diageo is much larger with an array of brands that includes the high-end Scotch Johnnie Walker as well as the moderately priced vodka Smirnoff and many others.
Diversity across segments and price points will keep these companies on track while they navigate through different economic and socio-cultural trends.
Continued performance
Both companies already have massive footprints in this industry and they could stand to get larger as the years go on. Diageo estimates that it sells products in approximately 180 countries worldwide. For fiscal year 2013, Diageo announced that emerging markets accounted for 42% of its net sales and increased scale in those markets helped grow the company's emerging markets operating margin by 18% that year . The slower-growing North American region accounted for 33% of sales in 2013 . Heavy weighting in emerging markets will help Diageo expand its revenue and earnings as the world economy becomes more developed in years to come.
Brown-Forman's latest annual report is littered with examples of its growing international presence. It is very clear that international growth is of high priority to the company. In fiscal year 2013, Brown-Forman sold products in 150 countries worldwide and international sales accounted for 59% of sales, up from under a third of the company's sales ten years ago .
Both companies give plenty of earnings back to their shareholders as well. Diageo gives back around 50% of its earnings to investors in the form of dividends each year. Brown-Forman has a smaller annual payout ratio of around 35%, but the company has paid out dividends for the last 68 years and raised the dividend each year for the last 30 years .
Bottom line
As of their latest reports, both companies are fairly conservatively financed. Brown-Forman has long term debt-to-equity of 0.54 and Diageo has long term debt-to-equity of 0.94, but it also has a strong history of earnings growth.
Currently the market values shares of Brown-Forman at around 30 times earnings and Diageo at around 18 times earnings. These compare to the industry average of around 17 times.
Both companies may be selling for higher prices than we would like but they are great companies to own. Brown-Forman and Diageo have had long histories of excellent performance and they are positioned for further growth, neither company is stressed by huge levels of debt, and they are in an excellent business environment.
You could buy pieces of these companies now, or keep an eye out for a time when the market prices them a little more modestly down the road.
