|Shares Out. (in M):||308||P/E||0||0|
|Market Cap (in $M):||22,405||P/FCF||0||0|
|Net Debt (in $M):||2,353||EBIT||0||0|
|Borrow Cost:||General Collateral|
I believe Brown Forman (“BF”) is an asymmetric short opportunity. Investors have been crowding into the name based on a thematic thesis (the “bourbon boom”) that is unsound and in the process of unraveling. With valuation vs. the S&P near record-highs, the potential for meaningful margin contraction, and an uninspiring EPS growth algorithm, shorting BF yields the potential for a meaningful de-rating (38% in reasonable downside case) while not risking much if the thesis doesn’t play out (6-12% total return algorithm at a constant multiple).
The thesis in brief:
BF is the largest American-owned spirits company, tracing its roots back to 1870 with the production of Old Forester Bourbon. It’s been a public company since 1933 although is family-controlled, with the Brown family retaining both a majority economic stake in the company and nearly all of the voting control (the more liquid “B” shares carry no votes) – as a result, the takeout risk is effectively zero. It has grown to more than 40 brands, the most notable being Jack Daniels, Old Forester, Woodford Reserve, Finlandia, Herradura, el Jimador, and Glendronach. Whiskey brands dominate their portfolio (~80% of sales), with the Jack Daniels brand constituting the vast majority of that category.
BF sells globally, with ~50% of sales going to the U.S., ~30% going to developed markets (e.g. UK, Australia, Canada, Europe), and ~20% going to emerging markets (e.g. Mexico, Poland, Russia, Brazil). The international markets skew more towards non-bourbon products (Finlandia is big in Europe, Tequilas are big in Mexico) while the U.S. market is driven heavily by bourbon sales (mostly Jack Daniels). This whiskey-focused mix stands out when BF is compared to other large global spirits companies which tend to have more diversified portfolios.
Within the bourbon category, BF has a leading share @ 32%, larger than Beam Suntory @ 28% (Jim Beam, Maker’s Mark, Knob Creek), Heaven Hill @ 6% (Evan Williams, Elijah Craig), Sazerac @ 4% (Buffalo Trace) and all other brands @ 30% (Wild Turkey, Four Roses, Bulleit, etc.).
Industry Backdrop & Current Situation:
The most important thing to appreciate about the current industry dynamics is that the spirit industry, and particularly the bourbon category, is experiencing something of a renaissance. This should be no surprise to those of you who are spirit consumers – over the last ten years spirits have continued to take share (mostly from beer), and bourbon has gone from something your dad (or grandfather) drank, to an integral part of cocktail culture with continued premiumization driven by appreciation for the more complex flavor profile of “brown spirits” over e.g. vodka. This massive increase in interest has increased bourbon’s share of spirits from the ~9-10% level 10 years ago to 13-14% today, outgrowing the spirits industry by ~300-400bps per annum, and has resulted in significant pricing power, particularly in the super-premium segment where it is not uncommon to find a plethora of bottles in the $50+ range and rarer bottles going for well over $100.
BF has done a good job of positioning itself to capture these trends over the years (although at a meaningful cost), divesting non-core brands like Southern Comfort and Hopland wines, developing/buying brands like Slane Irish Whiskey, BenRiach and Woodford Reserve, and developing brand extensions like Jack Daniel’s Tennessee Fire and Honey. That being said, its over-indexing to the whiskey/bourbon category, while a tailwind over the last decade, is likely to create issues for them going forward, as I’ll discuss below.
1. BF gets a rich valuation because it is the closest thing to a pure-play bet on the bourbon boom, although this logic is misguided
It is well-understood that the bourbon category is booming, and with a very heavy skew to the bourbon/whiskey category, the thematic bull case for BF is that they are likely to be a beneficiary of this trend. As a result, BF trades at a nosebleed valuation of 27x EPS and 21x EBITDA on consensus forward estimates. To put this valuation in perspective, I’ve graphed the relative P/E multiple for BF vs. the S&P going back to 2006. At a current premium of 80% to the S&P, BF is near all-time highs. Before bourbon started booming (say 2006-10), the average premium was 30%, since then it has averaged 65% - compared to either things look frothy.
BF also trades at a premium to the other global spirits companies – while BF trades at 21x EV/EBITDA, the average comp is at 17x. Pre-2011, BF traded in-line with the group, which at the time was a low double digit multiple (~10-13x EBITDA).
So why is the thematic bull case logic misguided? In addition to structural supply/demand issues that I will explore later, put simply, Jack Daniels (the vast majority of BF’s bourbon portfolio) is basically the worst-trajectory brand in bourbon right now. If you look at the underlying drivers of the bourbon renaissance (cocktail culture, premiumization, desire for complex flavor profiles), Jack Daniels really doesn’t play to these themes at all. This is why, despite new brand extensions like Honey and Fire, the Jack Daniels brand is losing ~100-150 bps of market share every year like clockwork and their overall share has gone from the low 40s in 2014 to the low 30s currently, as measured by Nielsen. While the rest of the bourbon category has grown volumes at ~8% p.a. over the last 5 years, their core JD Tennessee Whiskey is only managing growth of 2-3% in the midst of the greatest whiskey boom ever. In addition to having a brand that is less “on-trend” than others, I believe this share loss is also due to a cumulative advertising deficit – BF/B has significantly underinvested in advertising for close to a decade now, and this is finally catching up with them: