Brown-Forman (BF'B)

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Brown-Forman has grown despite a general decline in alcohol consumption in the United States, its primary market. This is because of recent consumer trends away from beer and towards premium spirits, which represent over 70% of the firm's portfolio. As a distiller, the firm's margins have been affected by the sharp rises in commodity prices, though not as much as those of brewers.

The firm faces intense and ever-increasing competition in the largely stagnant alcohol industry, where it competes with large conglomerates such as Diageo (DEO) and Constellation Brands (STZ) as well as brewers such as Anheuser-Busch Companies (BUD) and Molson Coors Brewing Company (TAP). The primary avenues for growth for producers of alcohol are developing markets, where Brown-Forman is relatively weak. Although the company's products are available in over 135 countries, markets outside of the US and Europe accounted for only 18% of sales in 2007.

[edit] Business Financials

Brown-Forman manufactures and distributes 35 brands of alcoholic beverages worldwide, though the United States accounts for 53% of sales. The firm’s best-selling products include Jack Daniel’s Tennessee Whiskey (the most popular American whiskey brand in the world), Southern Comfort (the second most popular liqueur in the United States) and Canadian Mist (the third-largest selling Canadian whiskey worldwide.) Accounting for 30% of sales by volume, Jack Daniel’s in particular is central to the firm’s success.^[1] Until recently, the company manufactured durable goods such as luggage and oak barrels, but it has sold off these operations to focus on its primary business.^[2]

^[3]

Brown-Forman has regularly used strategic acquisitions to grow its international operations. For instance, it acquired Finland’s Finlandia Vodka in 2004, France’s Chambord Liqueur in 2006, and Mexican tequila producer Casa Herradura in 2007. This last acquisition specifically holds much promise for the firm, as tequila is one of the fastest growing spirits worldwide, and Casa Herradura’s brands are strong in the US and Mexico, the world’s largest tequila markets.^[4]

^[5]

After slipping in 2003, sales have grown steadily for the past 4 years at a Compounded annual growth rate - CAGR of 11.5% Operating income has kept pace, growing at a CAGR of 12% in the past 5 years (16% in the last four years). Growth has been focused in non-US markets; in 2007, for instance, three quarters of total growth in net sales came from outside of the United States.

2007 sales grew 16%, lifted both by acquisitions and organic growth in price and volume. Geographically, sales outside of the United States grew 30%, compared to 7% for US sales, reflecting a more dynamic market environment (high demand, beneficial foreign currency adjustments) as well as efforts by the firm to streamline its distribution and excise tax collection processes in Germany and Australia. Jack Daniels super-premium brands, which account for less than 10% of sales, saw double-digit growth rates in 2007 as well. ^[6]

The company is continuing to invest heavily in expanding production capacity, especially for Jack Daniels and Casa Herradura products, increasing this spending by 70% over the next three years. Advertising costs comprise another area of expense growth - because the firm considers its brand equity to be its most important competitive advantage, it invests heavily in advertising in international and, to a lesser extent, domestic markets. In 2007, advertising grew 12%. ^[7]

[edit] Key Trends, Risks, and Forces

[edit] Demand

• Decline in US Alcohol Consumption Decreases Demand: Alcohol consumption per capita has been declining for the past few decades, falling 26% from 1980 to 2000. Several demographic trends are contributing to the decrease, including the aging of the US population (older people tend to drink less) and the rising level of education in the country (alcohol consumption is negatively correlated to education). As a result, alcohol producers face a stagnant market with low growth prospects. ^[8] Brown-Forman in particular stands to lose from this trend as the majority of its sales are concentrated in the United States.

^[9]

• Shift of Alcohol Consumption Away From Beer Raises Demand For Wines and Spirits: The global spirits market has benefited from a shift in consumer tastes from beer to higher-priced and trendier alcoholic drinks such as wine and spirits. Even within the wine and spirits segments, consumers are increasingly choosing premium and superpremium brands.^[10] In Western Europe and some areas of the United States, this trend has been enhanced by prohibitions against smoking in restaurants and bars, which threaten to move alcohol consumption into the home, where wines and spirits are the drinks of choice. Brown-Forman is well-positioned to benefit from this shift in demand, since it sells primarily premium wines and spirits. As a result, the firm has been able to raise the prices for many products while still growing volume.^[11]

• Higher Demand in Emerging Markets Necessitates International Focus: Emerging economies with rapidly expanding numbers of newly wealthy consumers have established themselves as the primary source for growth in demand for luxury goods ranging from handbags to haute couture. Premium and super-premium liquors are no exception; with US demand almost flat, distillers have had to turn to new markets. Brown-Forman has moved to respond to these trends by expanding its international presence through increased advertising for established brands in new markets and international acquisitions. For instance, Finlandia Vodka's primary market is Poland; its sales in Russia and Israel are also growing at double digit rates). The results are apparent in the shift of sales away from the United States market, which accounted for 53% of revenues in 2007 compared to 80% in 1994.^[12]

[edit] Supply

• Rising Commodity Prices Affect Production Costs: Commodity prices have risen dramatically over the last year. This has hit the alcohol industry hard, since agricultural commodities, such as grains, are key ingredients in producing all types of alcohol. However, brewers have suffered much more than distillers, since agricultural commodities make up a larger percentage of the cost of beer. Thus, although Brown-Forman's costs are rising along with commodity prices, the firm's products actually have the potential to become cheaper in relation to beer, providing a competitive advantage over indirect rivals such as Anheuser-Busch Companies (BUD) and Molson Coors Brewing Company (TAP). ^[13]

• Potential Increases in Excise Taxes Put Pressure on Margins: Taxes and other fees account for over half of the retail cost of alcohol. However, because the average consumer is not aware of this fact, distillers usually cannot raise prices when these taxes increase. Consumers would perceive such a move as price gouging, strongly decreasing demand.^[14] Hence, Brown Forman's margins would be strongly affected by increases in excise taxes in any of the countries where it does business, but especially in its largest market, the United States.^[15]

[edit] Competition

The global alcoholic beverages industry is mature, and has posted low growth rates (2-3% annually) over the past decade. Due to this, industry participants compete primarily for existing market share through acquisitions, though the development of innovative products to differentiate themselves from the competition (mixed drinks, creative packaging, etc) is also a focus for many. Brown-Forman, which holds 5% of the US market, ^[16] competes primarily with other producers of wine and spirits, though makers of substitute products (most significantly beer) are also indirect competition.

• Constellation Brands (STZ) is a wine, spirits, and beer company with over 250 brands under management sold in over 150 countries. Its wine subsidiary, Constellation Wines US, accounts for 55% of its net sales and is the leading global wine producer based on volume. The firm has about 20% of the U.S. wine market and 5% of the global market. Constellation is much larger than Brown-Forman and benefits from a comprehensive distribution network; however, Constellation's focus on wine minimizes the rivalry between the firms. ^[17]

• Diageo (DEO), the world’s largest producer and distributor of alcoholic beverages, was formed by the 1997 merger between Ireland’s Guinness and food and spirits manufacturer Grand Metropolitan. Its spirits, which include Johnny Walker Scotch, Jose Cuervo tequila, Smirnoff Vodka, and the recently acquired Captain Morgan rum, compete directly with Brown-Forman’s brands. Diageo is especially strong outside of Europe and the United States, where 30% of its revenues come from. By comparison, only 18% of Brown-Forman’s sales come from outside of Europe and the US. However, Brown-Forman’s focus on international expansion is narrowing the gap - its sales outside of the US and Europe grew 65% in 2007. ^[18]

• Fortune Brands (FO) A diversified consumer products company, Fortune Brands sells hardware and golf products in addition to spirits, which comprise 31% of sales. Its brands include Jim Beam and Maker's Mark bourbons. The company has grown through major acquisitions such as that of Allied Domecq in 2005, and partnerships such as its alliance with Starbucks to produce coffee liqueurs. However, its growth remains below that of Brown-Forman; in 2007, for instance, total sales in the spirits business grew only 3.7%, while international sales grew less than 7%.^[19] During the same year, Brown-Forman's total sales rose 16%, and international sales grew 30%.

[edit] Footnotes

1. ↑ 2007 10-K. Section 1 Business. Pg 2
2. ↑ 2007 10-K. Section 7 Management's Discussion and Analysis. pg 26
3. ↑ 2007 10-K. Section 7 Management's Discussion and Analysis. pg 29
4. ↑ Increased Demand for Tequila Spikes Production
5. ↑ 2007 10-K. Section 6 Financial Highlights. Pg 24
6. ↑ 2007 10-K. Section 7 Management's Discussion and Analysis. pg 26-29
7. ↑ 2007 10-K. Section 7 Management's Discussion and Analysis. pg 30
8. ↑ Alcoholic Beverage Consumption in the US
9. ↑ Alcoholic Beverage Consumption in the US
10. ↑ 2007 10-K. Section 7 Management's Discussion and Analysis. pg 26
11. ↑ Good News for Jack Daniels
12. ↑ Brown-Forman 2007 Annual Report Executive Overview pg. 29-32
13. ↑ Raise a Glass to These Alcohol Picks
14. ↑ Alcohol Prices, Quality, and the Demand for Alcohol
15. ↑ 2007 10-K. Section 1 Business. pg 6
16. ↑ Good News for Jack Daniels
17. ↑ Constellation Brands Wikinvest Profile
18. ↑ Diageo Hoover’s Profile
19. ↑ Fortune Brands Wikinvest Profile