Which Bottle to Crack Open?

 | Jul 05, 2013 | 2:15 PM EDT
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Jack Daniels maker Brown-Forman (BF.A, BF.B) just had a modest shot of insider buying. In the past few days, a trust related to 13.7% owner J. McCauley Brown -- a member of the Brown family, which owns the majority of the thinly traded Class A voting shares -- purchased another 5,000-plus shares of premium stock. (The common Class B stock confers financial interest only, with no voting rights.) So let's look into the company a bit further.

For all of fiscal 2013 (ended April) Brown-Forman -- which also makes Southern Comfort, among other alcoholic brands -- said sales rose 5%. Thanks to this, in addition to well-controlled costs, net earnings climbed 15%, panning out at $2.75 per share for the year. Top-line growth was weak in the largest geographic segment, the U.S., which accounts for about 40% of total revenue. But that was more than offset by good numbers in the rest of the world, even including 7% sales growth in Europe.

Cash flow from operations has not changed much over the past couple of fiscal years. However, the business requires very little in the way of capital expenditures, so historically most of this cash flow has been returned to shareholders through share buybacks and dividends. Brown-Forman paid a large special dividend in the past year, although regular quarterly payments imply an annual yield of only 1.6%.

While the business is doing well, markets have already priced in a good deal of improvements. As a result, the current $14 billion-plus in market capitalization equates to 25x trailing earnings, which seems like an aggressive valuation. While growth has been positive and stable, we are skeptical that demand for alcoholic beverages will remain strong enough to fuel double-digit growth rates. Also note that improved margins were key to recent results -- and that such metrics likely aren't a sustainable source of earnings growth.

Even looking ahead to the next fiscal year (ending April 2015), Brown-Forman looks pricey, with a multiple of 21x those estimates. We would, however, note that the stock has little exposure to the overall economy, sporting a beta of 0.5.

Jim Beam purveyor Beam (BEAM), one of Brown-Forman's closest peers, is also priced at a premium valuation. In fact, Beam's trailing and forward earnings multiples -- which are 24x and 22x, respectively -- are close matches to those of Brown-Forman. Yet Beam's first-quarter sales rose 8%, and earnings swelled by more than 40%, with net margins rising even more strongly there than at Brown-Forman.

We'd be interested in examining Beam more closely to see if this superior performance is sustainable. If so, that stock might make for a better investment prospect than Brown-Forman, given that the two companies essentially share the same valuation metrics.

Overall, then, we don't think it's advisable to imitate the insider purchase at Brown-Forman. While earnings numbers there have been strong, the sales numbers have not been as good, and the crucial U.S. market has seen even lower revenue growth than has the rest of the company. If the stock were trading at an earnings multiple in the teens, its recent performance might be more intriguing. But, at current levels, it doesn't seem like a good value.

Beam -- which has been reporting better financials -- and, possibly, other alcoholic beverage companies, would seem to be more worthy of further research.

-Written by Matt Doiron

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