As has been the case with other names in the spirits business like Diageo (NYSE:DEO) and Beam (NYSE:BEAM), investors seem comfortable overpaying to own the stock of Brown-Forman (NYSE:BF.B). Certainly there is a growth angle to this story, as the company looks to extend its world-leading share in bourbon to new markets like China. That said, even high single-digit free cash flow growth isn't enough to push the fair value estimate to an attractive level.

Investopedia Broker Guides: Enhance your trading with the tools from today's top online brokers.

A Reasonable Close to the Year
Brown-Forman reported respectable results for the fiscal fourth quarter. Although reported net sales was up just 1%, that was better than expected. What's more, the underlying sales growth was more on the order of 10%, and the company continues to see a good recovery in its core Jack Daniel's business, as well as growth from new brand extensions like Jack Daniels Tennessee Honey.

Margins and profits were OK, but not quite as strong as sales. Gross margin (excluding excise taxes) improved more than half a point, and underlying operating income did grow 13%. Nevertheless, the company did post a slight miss for the quarter and guidance for the next year wasn't exactly blistering.

SEE: How To Use Price-To-Sale Ratios To Value Stock

Still Largely a Single-Story Stock
While Brown-Forman is seeing better performance from its Finlandia vodka business, the reality is that Jack Daniels is still nearly 50% of the company's volume. On one hand, the fact that Brown-Forman and Beam pretty much dominate the bourbon market does reduce the risk from being so heavily dependent on one category. Still, it's worth noting that Brown-Forman management is just sitting on an old tried-and-true formula. The company has been getting more active of late in developing new flavored and premium products, and the market acceptance (at least in North America) has been pretty solid. That said, it still lacks the ability of a company like Diageo to market a wide range of brands into emerging markets and respond to whatever the consumers' tastes happen to be.

SEE: The Risks Of Investing In Emerging Markets

Just How Dependable Is This Market?
I suspect that a lot of the investor enthusiasm for names like Diageo, Beam and Brown-Forman stems from the seemingly low-risk business models. After all, people who drink tend to drink in good times and bad, and the business of spirits can look like good high-margin options when the economy gets shaky.

That's fair, but only to a point. Spirits are heavily taxed and it is worth asking if governments will resist the temptation to ratchet up excise taxes on spirits. Should that happen, consumers may be forced to consume less, switch to cheaper brands, or switch away from spirits entirely. Historically, beer companies like Anheuser-Busch InBev (NYSE:BUD) and Molson Coors (NYSE:TAP) have done a good job of fighting back on tax increases on beer and the higher per-bottle value of spirits tends to make them a more appealing target.

SEE: What Countries Get For Their High Taxes

The Bottom Line
Brown-Forman would fit in nicely with Diageo, Pernod or Bacardi, but the nature of the company's ownership is such that I wouldn't expect a sale of the company. More likely is that management will look for further deals along the lines of Chambord and Casa Herradura to augment their product offerings and better leverage their distribution channel.

While I like the Brown-Forman business and can make my peace with the company's dual-class share structure, I don't like the price. Even with double-digit returns on capital and the world's leading U.S. whiskey brand, I don't like to pay a mid-teens EV/EBITDA multiple for a business with this sort of growth profile. A discounted cash flow model likewise suggests that Brown-Forman offers little fundamental value at these levels.

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

Related Articles
  1. Investing

    Time to Bring Active Back into a Portfolio?

    While stocks have rallied since the economic recovery in 2009, many active portfolio managers have struggled to deliver investor returns in excess.
  2. Economics

    Investing Opportunities as Central Banks Diverge

    After the Paris attacks investors are focusing on central bank policy and its potential for divergence: tightened by the Fed while the ECB pursues easing.
  3. Stock Analysis

    The Biggest Risks of Investing in Pfizer Stock

    Learn the biggest potential risks that may affect the price of Pfizer's stock, complete with a fundamental analysis and review of other external factors.
  4. Stock Analysis

    Allstate: How Being Boring Earns it Billions (ALL)

    A summary of what Allstate Insurance sells and whom it sells it to including recent mergers and acquisitions that have helped boost its bottom line.
  5. Options & Futures

    Cyclical Versus Non-Cyclical Stocks

    Investing during an economic downturn simply means changing your focus. Discover the benefits of defensive stocks.
  6. Markets

    PEG Ratio Nails Down Value Stocks

    Learn how this simple calculation can help you determine a stock's earnings potential.
  7. Investing Basics

    How to Deduct Your Stock Losses

    Held onto a stock for too long? Selling at a loss is never ideal, but it is possible to minimize the damage. Here's how.
  8. Investing

    Retailers Rebel Against Black Friday: Bad Move?

    The Black Friday creep may have hit a wall as some stores are shutting their doors on Thanksgiving and even Black Friday to give employees the day off.
  9. Investing

    What’s the Difference Between Duration & Maturity?

    We look at the meaning of two terms that often get confused, duration and maturity, to set the record straight.
  10. Economics

    Is Wall Street Living in Denial?

    Will remaining calm and staying long present significant risks to your investment health?
  1. What does low working capital say about a company's financial prospects?

    When a company has low working capital, it can mean one of two things. In most cases, low working capital means the business ... Read Full Answer >>
  2. Do nonprofit organizations have working capital?

    Nonprofit organizations continuously face debate over how much money they bring in that is kept in reserve. These financial ... Read Full Answer >>
  3. Can a company's working capital turnover ratio be negative?

    A company's working capital turnover ratio can be negative when a company's current liabilities exceed its current assets. ... Read Full Answer >>
  4. Does working capital measure liquidity?

    Working capital is a commonly used metric, not only for a company’s liquidity but also for its operational efficiency and ... Read Full Answer >>
  5. How do I read and analyze an income statement?

    The income statement, also known as the profit and loss (P&L) statement, is the financial statement that depicts the ... Read Full Answer >>
  6. Can working capital be too high?

    A company's working capital ratio can be too high in the sense that an excessively high ratio is generally considered an ... Read Full Answer >>

You May Also Like

Trading Center