Fortune Brands (FO)

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Fortune has had steady revenue growth over the past five years, though the 2007 economic slowdown took its toll on that year's results, leaving revenues virtually flat year on year. The Home and Hardware business, the firm's largest, is particularly vulnerable to housing slowdowns, and has been hit significantly by last year's subprime crisis. The Spirits sector faces rising commodities costs, but global demand has trended towards the premium and super-premium drinks that Fortune produces (and away from cheaper spirits and beer), improving that sector's short term outlook. Golf, the firm's smallest segment, has benefited from the growing popularity of the game abroad; the segment performed well in 2007 despite heavy regulations by governing bodies (the USGA) which limited product innovation.

All three of Fortune Brands' units compete with large consumer products firms (for instance, Black & Decker (BDK) in Home and Hardware, Brown-Forman (BF) in Spirits, and Nike (NKE) in Golf. Fortune's brands are often #1 or #2 in their markets, and the company regularly supplements its portfolio with strategic acquisitions. The diversity of its holdings also protects it, to a degree, against downturns in any particular market - but all three of its core businesses depend on consumers' discretionary income to build revenues.

[edit] Business Financials

Fortune Brands is a holding company for its three businesses: Home and Hardware, Spirits, and Golf. Home and Hardware is the largest segment, accounting for 53% of 2007 revenue; Spirits is the second largest with 31%; and Golf, the smallest, accounted for 16%. The company has grown its two smaller businesses over the past few years to minimize dependence on home improvement and construction products -only two years ago, Home and Hardware comprised over 60% of sales. ^[2]

[edit] Home and Hardware

Home and Hardware brands include Moen, Omega, and Kitchen Craft. More recently, the company acquired Therma-Tru residential entry-door and patio-door systems and Simonton vinyl-framed windows. The operations cover home improvement and construction activity, including: repair, remodeling, and new construction.^[3] The unit is particularly strong in the cabinet and faucets businesses, which continue to gain market share. Having established its position as the exclusive cabinet supplier to Home Depot and Lowe's, the company is concentrating on adding other stores to its portfolio. The unit is benefiting from continued new product introductions, market share gains, the company's strong presence in the replace-and-remodel segment of the housing market, and penetration in new overseas markets like Asia, Latin America, and Europe. In order to cope with the ongoing slowdown in the U.S. housing market, management is undertaking various measures, like consolidating manufacturing facilities, which resulted in the closure of several facilities year-to-date; discontinuing a number of production shifts; implementing reduced work weeks at several facilities; and reducing overhead and administrative structures. These efforts led to significant headcount reductions in this segment. In total, over the past year, the company has reduced its hourly and salaried headcount in Home and Hardware by more than 10%.^[4]

[edit] Spirits

After completing the sale of its entire US wine business to Constellation Brands in 2007, the company's second-largest segment consists exclusively of distilled spirits. The business is managed by Beam Global Spirits & Wine, Inc. (BGSW), and its subsidiaries. Major brands include Jim Beam and Maker's Mark bourbons, Sauza tequila, Canadian Club whisky, and Starbucks liqueurs. The business is the fourth largest distiller in the world. The unit has benefited from strong sales of its premium and super premium brands. Fortune Brands is widening the unit's geographical reach by introducing products in the emerging economies of Russia, China, and India. The company is investing more than $70 million over a five-year period in capacity expansions and energy cost reductions for both Jim Beam and Maker's Mark, and is also making multi-million dollar investments in plant upgrades, which is also reducing its energy costs. The company's strategic alliance with Starbucks Coffee Company in the coffee liqueur business adds another growth driver. ^[5]

[edit] Golf

With brands that include Titleist, Pinnacle, and Footjoy, the firm holds the highest market share in the golf equipment industry, manufacturing everything from golf clubs to shoes and outerwear. Growth in every product line, particularly in the Titleist, FootJoy, and Cobra brands; new product introductions; increasing market share (reflecting the growing success of its brands); and continued growth and the firm's investment in international markets have grown sales.

^[6]

Both revenues and operating income have grown briskly over the last five years, despite the effects of the 2007 housing slowdown on the Home and Hardware segment. Even including the 2007 decline, revenues have increased at a Compounded annual growth rate - CAGR of 17%, while operating income has grown at a CAGR of 14%. Major growth drivers include new product development, which accounts for 20% of revenues, as well as growth in international markets.

Strategic acquisitions and divestitures have also contributed to revenue growth. In the spirits space, Fortune acquired over 25 brands and distribution assets, including Sauza tequila, Maker’s Mark bourbon, and Canadian Club whisky, from Allied Domecq in 2005. The purchase gave the firm access to several key international markets, specifically the U.K., Spain, and Germany.^[7] In Home and Hardware, Fortune Brands recently acquired Therma-Tru doors and SBR, Inc, owner of a leading vinyl-framed window brand. This last acquisition enables the firm to capitalize on the higher-margin vinyl-framed windows market and boost its Home and Hardware business.

At the same time, divestitures have sharpened the firm's focus. For instance, in 2005, Fortune Brands spun off its office products business, ACCO World Corporation into its own company. In 2007, the firm completed the sales of its wine brands to several competitors, most significantly wine and spirits conglomerate Constellation Brands (STZ).^[8]

In 2007, revenues remained virtually flat (increase of 0.5%), while net income fell 8%, reflecting the effects of weakness in the housing market on the Home and Hardware segment, where sales fell 3%. These effects were mitigated, however, by the success of the Spirits business, whose operating income grew 16% (on 4% sales growth), buoyed by an increase in demand for premium and super-premium brands and resulting price increases, as well as a gain on the sale of The Dalmore Scotch Whisky brand.^[9]The Golf segment also performed well in 2007, with sales rising 7% after successful introductions of new golf clubs and golf shoes, as well as market share gains both at home and abroad. ^[10]

[edit] Key Trends, Risks, and Forces

[edit] Home and Hardware

• Subprime Crisis Decreases Home and Hardware Sales: About a third of the sales in the Home and Hardware segment come from new construction (the rest are related to home improvement). While this partially limits the unit's exposure to weakness in the construction industry, Home and Hardware sales have already fallen 3% in 2007, with operating income plunging 28%. Further weakness in the housing market may continue to weigh heavily on profits.^[11]

[edit] Spirits

• Rising Grains Prices Affect Production Costs: Commodity prices have risen dramatically over the last year. This has hit the alcohol industry hard, since agricultural commodities are key ingredients in producing all types of alcohol. Fortune Brands' products, for instance, use corn, grains and grapes, resulting in cost increases for the firm's Spirits segment.^[12] However, brewers have suffered much more than distillers, since agricultural commodities make up a larger percentage of the cost of beer. Thus, Fortune Brands' spirits, despite rising costs, 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).
• 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.^[13] Fortune Brands is well-positioned to benefit from this shift in demand, since it sells primarily premium spirits (70% of total volume). As a result, the firm has been able to raise the prices for many of its products while still growing volume.^[14]
• Purchase of Absolut Vodka Producer by Pernod Ricard Creates Stronger Competitor and Jeopardizes Joint Venture: Last year, the Swedish government put up state-owned alcoholic beverage producer Vin & Spirit for sale as part of a strategy to pay down government debt. After a four-way competition for the firm, which owns Absolut Vodka, French competitor Pernod Ricard beat out Fortune Brands and other bidders with an offer of $9.24 billion.^[15] Fortune, which was viewed as the favorite to win the bidding contest, will now have to deal with a much stronger competitor rivaling Diageo (DEO) as the world's largest alcoholic beverage producer. Another difficulty for the firm is the fact that it currently holds the distribution rights to Absolut in the United States, the product's largest market, through a joint venture. Pernod Ricard plans to end the joint venture in the next few years in order to assume full control of Absolut's distribution, which will have a negative impact on Fortune's bottom line.^[16]

[edit] Golf

• A Decline in the Popularity of Golf Can Lower Sales: The number of golfers in the United States has not grown in years, actually declining from 30 million in 2000 to 26 million in 2007. The number of regular golfers (people who play 25 times or more per year) has been falling even faster, declining by a third in the same time period. Because suppliers ratcheted up the construction of courses and production of equipment in anticipation of a spike in demand caused by the baby boomers' retirement that never came, the mismatch between supply and demand has led to struggles in the golf industry.^[17] Although Fortune Brands' golf unit has nonetheless continued to grow sales on the strength of its well-recognized brands like Titleist, Footjoy, and Pinnacle, further declines in demand could have an impact on its growth.

^[18]

• Golf Regulation Restricts Potential for Innovation: Regulatory bodies such as the United States Golf Association keep a close watch on the golf equipment industry, setting standards on the technical specifications of each product. Guidelines cover details ranging from club adjustability to golf ball distances.^[19] As a result, product innovation for Fortune and rivals like Callaway is a limited competitive advantage. Manufacturers instead must compete primarily by strengthening brand image and securing professional endorsements, a strategy that escalates marketing costs.^[20]

[edit] Multi-Segment

• All Three Businesses Are Heavily Dependent on Strength of US Economy: Fortune Brands' holding company structure is designed to protect the company as a whole from weakness in one segment. However, all of its products are relatively discretionary items, and when consumers have less money in their pockets Fortune's sales inevitably decline. The expensive leisure activity of golfing, high-margin premium spirits, and home remodeling projects are easily foregone in a recessionary period, such as the one threatening in 2008. While the declines in consumer spending and confidence have so far had a minimal impact on either the Spirits or the Golf businesses, a prolonged recession will lower sales and operating income in both.^[21]

• 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. Both the Spirits and Golf segments have benefited from this shift. With US demand for golf products and premium and super-premium liquors almost flat, Fortune Brands has had to turn to new markets. The firm has positioned itself to benefit from the growth in international demand with moves such as the acquisition of the Allied Domecq brands in 2005, which have increased the Spirits segment's international exposure to 1/3 of sales. Its faster growing markets are currently India and Australia.^[22] The Golf business also takes advantage of growing demand in developing markets such as China.^[23]

[edit] Competition

Fortune Brands competes with large, multinational consumer goods companies in each of its three segments. In all three businesses, the firm relies on selective acquisitions for growth. The company prides itself on restraint in choosing acquisitions, passing up overvalued opportunities. For instance, the firm recently passed up the chance to acquire the Absolut Vodka brand, which ultimately went to competitor Pernod Ricard. The other key aspect of Fortune's strategy is a focus on brands that are #1 and #2 in their markets - such brands account for 90% of total annual revenues.^[24]

Fortune believes that its holding company structure is also a competitive strength. The diversification such a structure provides can be a hedge against weakness in any particular market segment, as displayed most recently by the strength of the spirits and golf equipment businesses during the 2007 housing downturn. At the same time, the weak relation between the three businesses may dilute the company's focus and expertise, which has led to calls for the firm to split into three separate companies.^[25]

[edit] Home and Hardware

• Masco (MAS) Masco is a home improvement company selling a diverse variety of products, most significantly cabinets and faucets, which account for over half of sales. Other products include bath and shower accessories, paints, windows, and patio doors. Home Depot is the firm's largest customer, accounting for 20% of total sales. Masco benefits from a focus on cabinets and faucets, which are some of the most popular and high-margin products in the home improvement business.^[26] Masco and Fortune Brands' Home and Hardware division offer almost the same products; however, the former is much larger, with almost $12 billion in sales.
• Black & Decker (BDK) Although Black & Decker is best known for its power tools segment (it is the world leader in power tools and accessories), the company also manufactures hardware and home improvement products, which include security hardware, kitchen and bathroom accessories and replacement parts. This segment accounts for nearly 16% of its total sales. Like Fortune Brands, Black and Decker's profitability is heavily dependent on the status of the housing market. The firm has been able to shield itself somewhat from the most recent housing crisis through diversification, but its products are more tied to housing than those of Fortune Brands. Black and Decker has shown itself to be quite successful at developing new products and converting them into revenues; however, 35% of annual revenues come from products introduced during the previous year (Fortune Brands receives 20% of revenues from products introduced during the previous three years).^[27]

[edit] Spirits

• 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 Fortune's Spirits segment and benefits from a comprehensive distribution network; however, Constellation's focus on wine minimizes the rivalry between the firms. ^[28]
• 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 Fortune Brands. Diageo is especially strong outside of Europe and the United States, where 30% of its revenues come from.^[29]
• Brown-Forman (BF) Brown-Forman produces over 30 brands of wines and spirits, including Jack Daniel's Whiskey and Southern Comfort. The firm focuses primarily on premium and super-premium brands, and thus competes directly with Fortune Brands' offerings. Brown Forman's weak international position puts it at a disadvantage against Fortune Brands. However, Brown-Forman’s focus on international expansion is narrowing the gap - its sales outside of the US and Europe grew 65% in 2007.^[30]

[edit] Golf

• Nike (NKE) Nike is a global producer of sports shoes, athletic apparel, and sports equipment. Its golf equipment falls into this last category, which makes up approximately 6% of sales. As the leading sports brand in the world, Nike has a clear marketing advantage over its competitors. Spending 11-12% of annual revenues on advertising allows the firm to build strong brands and secure top celebrity endorsements, key to growing market share in the golf equipment industry.^[31]
• Callaway Golf Company (ELY) Callaway produces a variety of golf equipment, including balls, clubs, and accessories for both professionals and amateurs. Of Fortune Brands' major competitors, it is the only one focused exclusively on golf. 47% of sales come from outside of the United States, which allows the company to counter stagnant growth in the domestic golf industry.^[32] This is significantly higher than Fortune Brands' golf unit's international sales (35% in 2006). A 2005 reorganization, which cut the firm's workforce by 13% and consolidated manufacturing facilities, has also increased the firm's profitability.^[33]

[edit] References

1. ↑ Kesmodel, David. "For Fortune Brands CEO, a Loss is a Win." The Wall Street Journal. April 11, 2008
2. ↑ Fortune Brands 10-K 2007. Section 6 - Selected Financial Data. pg 24
3. ↑ Fortune Brands 10-K 2007. Section 1 - Business. pg 6
4. ↑ Fortune Brands Q3 2007 Earnings Call Transcript
5. ↑ Fortune Brands 10-K 2007. Section 1 - Business. pg 6
6. ↑ Fortune Brands 10-K 2007. Section 6 - Selected Financial Data. pg 23
7. ↑ Fortune Brands 10-K 2007. Section 1 - Business. pg 6
8. ↑ Fortune Brands 10-K 2007. Section 1 - Business. pg 4
9. ↑ Spain, William."Fortune Brands profit hit by housing downturn." Marketwatch. January 25, 2008.
10. ↑ Fortune Brands 10-K 2007. Section 7 - Management's Discussion and Analysis. pg 25
11. ↑ Otte, Timothy. "Fortune Brands' Three-Putt." The Motley Fool. January 28,2008
12. ↑ Fortune Brands 10-K 2007. Section 1 - Business. pg 10
13. ↑ Kesmodel, David. "For Fortune Brands CEO, a Loss is a Win." The Wall Street Journal. April 11, 2008
14. ↑ Fortune Brands Q3 2007 Earnings Call Transcript
15. ↑ Kalambakal, Jupiter. "France's Pernod Ricard Buys Sweden's Vin And Spirit For $9.24B". AHN. March 31, 2008
16. ↑ Walsh, Dominic. "Pernod wins Absolut in fight for Vin & Spirit". The Times Online. April 1, 2008
17. ↑ Vitello, Paul. "More Americans are Giving up Golf." The New York Times. February 21, 2008
18. ↑ Callaway Golf Company Wikinvest Profile
19. ↑ US Golf Association
20. ↑ Fortune Brands 10-K 2007. Section 1 - Business. pg 10
21. ↑ Fortune Brands 10-K 2007. Section 1.A - Risks. pg 13
22. ↑ Fortune Brands Q3 2007 Earnings Call Transcript
23. ↑ Fortune Brands 10-K 2007. Section 7 - Management's Discussion and Analysis. pg 25
24. ↑ Barrett, Gordon. "Would Buffett Buy Fortune Brands?" Seeking Alpha. February 7, 2008
25. ↑ Kesmodel, David. "For Fortune Brands CEO, a Loss is a Win." The Wall Street Journal. April 11, 2008
26. ↑ Masco Hoover's Profile
27. ↑ Black & Decker Wikinvest Profile
28. ↑ Constellation Brands Wikinvest Profile
29. ↑ Diageo Hoover’s Profile
30. ↑ Brown-Forman Wikinvest Profile
31. ↑ Nike Wikinvest Article
32. ↑ Callaway Golf 2007 10-K. Section 1-Business. pg 5
33. ↑ Callaway Hoover's Company Profile