Friday, January 16, 2015

Brown-Forman Corporation Dividend Review

Brown-Forman Corporation (BF.A)(BF.B) is engaged in the manufacture, bottling, import, export, marketing, and sale of alcoholic beverages. It provides whiskey, ready-to-drink cocktails, vodka, tequilas, champagnes, wines, liqueur, and other distilled spirits.

Right before Thanksgiving Week, the company raised its quarterly dividend by 8.60% to 31.50 cents/share. This dividend champion has increased dividends for 31 years in a row, and paid them for 69 consecutive years.

Paul Varga, the chief executive officer of Brown-Forman shared the following information in the press release:, “This dividend increase marks the 31st consecutive year of increases at the company, and reflects our commitment to delivering top-tier returns for our shareholders. In addition to returning cash to shareholders through our dividend program, the company also implemented a new buyback program in October, and is aggressively investing behind the long-term global growth of our American whiskey brands.”

Brown Forman is the type of dividend growth stock which has a portfolio of strong brands, which generate stable and recurring sales and profits, around the globe. Over time, I would expect that earnings per share will increase, that dividends increase, and that it maintains pricing power that allows it to sell more of its unique products. This is the type of business which will be around in 20 years, and which will still be able to generate high returns on investment, that will translate into more dollars flowing into shareholders pockets. In other words, after I last analyzed the company, I have decided that this is the type of buy and forget, sleep well at night company to hold for the next 20 -30 years.



The problem that I have had with Brown Forman over the past 30 points is its current valuation. The stock is selling for somewhere between 27.20 to 29 times expected fiscal year 2015 earnings per share. The earnings per share are expected to come somewhere between $3.25 to $3.45. The yield based on the new dividend payment is 1.35%. Despite the fact that annual earnings per share growth could likely be around 8% - 10% over the decade, it is evident that the valuation today is rich. As a result, it is very likely that investors who own Brown-Forman today or those who somehow buy at todays valuations are very likely to generate poor returns over the next five – six years.

In the case of Brown-Forman, I accumulated the shares in 2010, with an average cost of $39.98/share. At this time, the stock accounted for approximately 1.50% of my dividend portfolio. Given the contributions I have made in the past 4-5 years, Brown-Forman's share of my portfolio is approximately 0.50% today. Because it takes me years to build a sizeable position in my portfolio, this is no surprise of course. In the case of Johnson & Johnson (JNJ), where the stock has always been attractively valued in each year between 2008 and 2014, I have been able to put money to work regularly. If Brown-Forman is ever available at 20 times earnings, I would most probably double my exposure to the stock.

Companies like Brown-Forman confirm my belief that automatic dividend reinvestment could be a very poor capital allocation strategy. While your dividend income compounds faster when you reinvest it automatically, and you do not pay a commission to buy more stock, you are doing your capital a bad service by putting it to work in a stock that sells for over 27 times expected earnings. This is why I accumulate dividends in cash every month, and use them to buy shares in some of the most attractive ideas at the moment. Plus, I view dividends received as a rebate on my purchase price, which effectively reduces the amount of capital I have at risk in that particular company. I could then redeploy those funds elsewhere, thus effectively lowering my risk and increasing my portfolio diversification. In the past year, I have redeployed those dividends into shares of Diageo (DEO), which sell at better valuations.

The reason why I will still hold on to the stock however is my belief that the company can keep growing earnings per share in the high single digits for a considerable amount of time. Therefore, while the next 5-6 years could provide for lousy returns, I think that the next 20 years will provide for some good returns to the long-term investor. I have no problem “underperforming” some benchmark such as S&P 500 over a five year period with a company like Brown-Forman, because I know that this is the type of business that is built to last and could provide exceptional returns to my portfolio over the long-run. For example, let's assume earnings per share of $3.25 for FY 2015, and annual dividends of $1.26/share, with annual growth of 8% in both. This could translate into earnings per share of $14 and dividends per share of $5.40 in 20 years. At a P/E of 15, this translates into a price of $210/share and a total of dividends collected of approximately $58 over those 20 years, for a total return of 182%. This of course assumes contraction in P/E multiple, and no dividend reinvestment, as well as no taxes.

I also believe that selling outright is risky, due to taxes, opportunity cost and reinvestment risk. If I sold today, I would have to pay at least a 15% tax on capital gains of $54/share, which would leave me with $86/share ( assuming stock price of $94/share and cost of $40). I could potentially purchase shares of Diageo with the proceeds. However, I am not certain whether the dividend and earnings will grow as fast as those of Brown-Forman over the next 20 years. Plus, I always prefer to have some diversification, rather than be concentrated exclusively in one company. Thus I have reinvestment risk, which is the risk that the stock you sold could have done much better than the stock you purchased with the after-tax proceeds from the sale in the first place.

It is tough to make forecasts spanning 15 – 20 years down the road. However, the thing that provides confidence about making forecasts is the nature of the products and business of consumer staple companies such as Brown Forman. I know that in 15 – 20 years more people will be drinking quality alcoholic beverages, particularly those with highly recognizable brands such as Jack Daniels. There is brand loyalty, which translates into repetitive sales for years down the road.

I also like the fact that the company’s management is very shareholder friendly, and that they are able to raise the dividend for so many years. Long-term dividend investors might remember how in 2010 and 2012 Brown-Forman distributed special dividends to shareholders, which was right before the taxes on qualified dividends were expected to rise significantly. This is the type of management that looks out for shareholders, that I like. There are of course things that I do not like however, such as the program to repurchase shares at current valuations. I also do not like the dual-class shareholding structure, which gives the controlling family overwhelming voting power. If the stock price is ever depressed, they could take the company private at that low price, thus triggering losses for long-term shareholders. This is not as much of a risk with companies like Diageo. The other thing that makes Brown-Forman less valuable in my eyes is that there is a lower chance of it being acquired by someone, given the control of the Brown family. We saw how Beam was acquired for 30 times earnings, by Japanese company Suntory. Hence, the value of Brown Forman to a private buyer is approximately 30 times earnings under current conditions. However, given the control of the family, it is highly unlikely that such transaction would ever be consummated. However, one never knows too.

Overall, I think that Brown-Forman is the type of quality dividend champion to buy and hold for the long-term. If it ever falls to 20 times earnings, I would add to my stock position in the company. In the meantime, even up to 30 times expected earnings, it makes sense to own this company, due to its quality of earnings, and valuable portfolio of brands which are very likely to sell higher volumes to customers in the future. Selling this company stock would likely be a mistake, unless of course we get massive overvaluation.

Full Disclosure: Long BF/B and DEO

Relevant Articles:

Should you sell after yield drops below minimum yield requirement?
Brown-Forman (BF.A)(BF.B) Dividend Stock Analysis
Five World Class Dividend Stocks to Buy During the next dip
Opportunity Costs for Dividend Investors
Diageo (DEO) Dividend Stock Analysis


This article was written by Dividend Growth Investor. If you enjoyed this article, please subscribe to have future articles emailed to you [Email] or follow me on Twitter [Twitter]

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