Brown-Forman Analysis

I know there are a lot of stock analysis out there in the blogosphere. All the big dividend growth stocks like JNJ, KO, PG, XOM and MCD are well covered. I decided to analyze a stock that isn't been looked at as much. Recently I was looking at Brown-Forman. All data in this analysis is found in the 2013 Annual Report, found here: Investor relations Brown-Forman

Overview

Brown-Forman manufactures, bottles, imports, exports and markets a range of alcoholic beverage brands. A large chunk of its revenue comes from the Jack Daniel's line. The company produces recognizable brands for which consumers are willing to pay a premium in order to enjoy them. 

The company has been paying dividends since 1949 and raising it for 29 years, making it a Dividend Aristocrat. 

The Numbers

An overview of the last 10 years:

For convenience, I put the most important numbers in charts:

Net sales have grown from 1,992 million to 3,784 million. An average growth rate of 7.4% during those years.

Diluted EPS has grown from $1.06 to $2.75. An average growth rate of 11.2%.
Dividends (excluded special dividends) have grown from $0.43 to $0.98 per share. An average growth rate of 8%.

Some notes:

• Outstanding shares have been steadily decreasing from 228.7 million to 215 million. This means management is returning cash to share holders through buybacks.

• As we can see, Long term debt suddenly rose from $503 million to $997 million 2012 vs 2013. This might be a red flag and something to look further into. Although, the debt to capital ratio is at 35% which isn't exceptionally high if we look at the historical debt to capital ratio. 

• We can see very high profit margins, hovering in the low 20% for the last decade. Return on equity between 20% and 30% even through the Great Recession. Overall, the numbers seem pretty damn solid. 

Behind the Numbers

Of course, a company is not just numbers on a piece of paper. It's a real entity, providing high quality alcoholic beverages for the consumer to enjoy. The business provides jobs to 4,000 people. It rewards its shareholders. It creates economic activity which benefits society by generating taxable income, which supports our schools, military and social programs.

Here's an overview of some of the brands Brown-Forman produces:

A look inside a Brown-Forman Cooperage company. It shows men working and making the barrels in which the Bourbons and Whisky's get distilled.

Expected Returns

Today the stock trades at around 25 times earnings. This is not sustainable in my view for the long run. Let's say that in 2023 the stock will trade at 20x earnings. Now, I have to project EPS and dividend to be able to calculate total returns. Let's look at three possible outcomes. A "normal", an optimistic and a pessimistic scenario.

Normal scenario
The normal scenario: The next ten years Brown-Forman is able to perform in the same way it has for the last decade: Growing EPS at 11.2% and dividends at 8%. In 2023 the EPS would be $7.95 and along the way you would have gotten around $17.62 in dividends. Assuming you don't reinvest dividends, your total return would be 20x$7.95 + $17,62 = $176.62. Bought at today's price ($68.59) that would mean a compounded annual return of 9.9%

Optimistic scenario
The optimistic scenario:The next ten years Brown-Forman is able to perform  25% better than it has for the last decade: Growing EPS at 14% and dividends at 10%. In 2023 the EPS would be $10.19 and along the way you would have gotten around $19.98 in dividends. Assuming you don't reinvest dividends, your total return would be 20x$10.19 + $19.98 = $223.78. Bought at today's price ($68.59) that would mean a compounded annual return of 12.6%

Pessimistic scenario
The pessimistic scenario: The next ten years Brown-Forman is able to perform  25% worse than it has for the last decade: Growing EPS at 8.4% and dividends at 6%. In 2023 the EPS would be $6.16 and along the way you would have gotten around $15.55 in dividends. Assuming you don't reinvest dividends, your total return would be 20x$6.16 + $15.55 = $138.75. Bought at today's price ($68.59) that would mean a compounded annual return of 7.3%

Based on these assumptions Brown-Forman will generate between 7.3% and 12.6% shareholder returns through 2023, this is assuming you would not have reinvested dividends, if you do this, the calculated returns would be higher obviously.

Conclusion

Overall the company looks great. It holds a portfolio of great brands, it enjoys customer loyalty, high profit margins, solid growth numbers, possibility's to expand in emerging markets and international developed country's. This is a company I like to have a big stake in. To me, this company sort of resembles Coca-Cola, only with alcoholic beverages.

The company seems to be doing a good job consistently growing revenue, EPS and dividends. The company isn't very sensitive to recessions.

With quality comes a price. The stock isn't cheap right now, it trades at 25 times earnings. Based on today's fundamentals and future projections, I would pick up shares when we see it trading at $63.

Either fundamentals per share have to improve, or the market price would have to come down. I stay on the sidelines for now.

Thanks for reading

What I Look For in Dividend Stocks

My investing strategy entails purchasing high quality dividend growth stocks. The goal of my investing portfolio is to purchase stocks that will raise dividends in the future. The stream of dividend income will be used to fund my early retirement, making be completely financial independent. The dividend growth will protect my income stream against inflation.

But what exactly am I looking for in stocks. These are a few specific characteristics I'm looking for when researching stocks.

Strong competitive advantage
The first thing I'm looking for are strong competitive advantages. This is what Warren Buffett calls "wide moat businesses". It is very difficult to take away market share from such businesses due to their customer loyalty.

These features protect the companies from competitors and help them generate higher return on equity and charge higher prices to customers.

Wal-Mart, a very successful retailer, has marketed itself as the lowest price retailer for almost everything consumers spend their money on. Due to the size of Wal-Mart it is enable to to squeeze lower prices from it suppliers, they pass these low prices on to the customer. The low prices are Wal-Mart's competitive advantage.

The Coca-Cola Company, worlds biggest soft drink producers, is best known for its most prominent drink, Coke. It's a strong global brand, consumers a willing to pay a premium for the product. There are alternatives to Coke, like Pepsi, but any Coke drinker can taste the difference between a Coke and a Pepsi. The quality of Coca-Cola is the reason why multiple generations keep drinking the sugar flavored drink. This strong band name is a competitive advantage The Coca-Cola Company has. Another company with a portfolio of strong brand names is Philip Morris Co. It sells cigarettes outside the united states and owns the strong Marlboro brand.


A steady business model
A steady business model, what does that mean? It means that the business isn't subject to rapid changes. This results in shying away from start-ups and most technology companies. Technology has to be innovative, if it's not, it will lose its competitive advantages. In the tech sector, moats can evaporate quickly, we all remember Eastman Kodak, market leader in camera's in the past, now basically bankrupt. It failed to adept to the  a big market changer, the digital camera.

A steady business model like Coke is much more appealing to me. The company has been selling sugar flavored syrup for over 130 years now, this makes the profits very predictable and thus easy to predict future profits and future dividend growth.

Small companies do not have establish their moats yet. Shying away from small companies might result in me missing out on the next Apple. You just have to remember, for every success story like Apple, there are 100 not-so-success stories. I can't pick the next Apple, so I'm not trying to. I stick to steady businesses.


A strong balance sheet
When researching a stock, I always take a look at the balance sheet. I'm looking for a low debt/equity ratio.  I want the company to be able to cover its interest payments very generously (interest coverage ratio). I do not like companies with big debt loads, this could bring problems in the future when interest rates rise.

Some companies have huge amounts of cash sitting on the balance sheet. Microsoft for example has more than 70 billion dollars in cash & equivalents the last time I checked. This bale of cash, if used intelligently, can provide great shareholder returns. This money can be used for expansion of the business, acquisitions, share buybacks and dividends. A strong balance sheet is always a plus.



A history of paying and increasing dividends
Being a dividend growth investor, I focus on dividend paying stocks. I want my portfolio to produce a rising stream of income that protects my principal and income from inflation. Companies which have raised their dividend for decades typically are mature and  stable businesses, which generate a sufficient amount of cash to expand and share with the shareholders in the form of dividends and share buybacks. When a management has committed itself to raising the dividend year after year, it gets ingrained in the corporate culture.


An attractive valuation
I don't want to pay too much for a business. No matter how wonderful a company is, no business is worth any price. Overpaying for businesses could result in sub par total returns. We saw this during the dot-com boom or irrational exuberance in the late nineties. Household names like Coca-Cola and Wal-Mart were trading for 40 times earnings. The investor who bought stocks at those valuation were experiencing sub par total returns for the last 13 years.

As a rule of thumb, I do not to pay more than 20 times trailing earnings for a stock, unless I feel very confident about the future growth prospect of a business.


Conclusion
I briefly discussed a few characteristics I look for in businesses.Of course there are multiple other factors I take into account.  When I think of buying a stock, I don't ask myself the question: "What will go up next week?" I think about the things I discussed above. These are things make a business a good business, in my opinion.

When the business is good, the stock will eventually follow.


Thanks for reading

July 2013 Dividend Income Update

A bit of a disappointing month for me. INTC didn't raise the dividend. I decided not to sell yet and make a decision on whether to sell or not in the future. NSC did raise the dividend only 4%. I was really hoping for something a little bit more than that, given their previous raises were substantially higher. I also added some KMI shares to my portfolio.

All that said, dividends just keep rolling in like clockwork.

Here's the dividend update for July 2013:

Dividends Received

• MO: $15.40
• PM: $30.60
• GE: $12.54

Total dividend income for July: $58.54

Small month compared to the previous, but that's because only three positions paid me this month.

My 2013 goal is $1000, so far I'm 52.71% of the way there, my progress is tracked here.

Looking at the market, there aren't any stocks that stand out as bargains right now to me. Some things look fairly valued. I have some capital ready to allocate into a great business, if the opportunity arises, I'll grab it.

Thanks for reading