Brown-Forman Distills Growth Despite Trade Tensions

Although tariffs took a toll on profit margins and Brown-Forman (NYSE: BF-A) (NYSE: BF-B) missed analyst sales expectations, the owner of Jack Daniel's Tennessee whiskey still turned in a surprisingly strong performance in its fiscal 2019 third quarter.

Earnings per share of $0.47 came in ahead of the consensus estimates of $0.44, and pushed on by continued uptake of its super-premium bourbon offerings, Brown-Forman has so far overcome what could have been a very difficult period. Yet there are only so many costs the distiller can absorb, and that may weigh on its future performance.

Still the domestic leader

Underlying net sales rose 4% in the quarter compared to the year-ago period, driven higher by 21% growth in sales of super-premium brands Old Forester and Woodford Reserve. The latter is now on track to be the single largest contributor to Brown-Forman's U.S. growth this year, and the distiller says the former is positioned to be "a real leader in the renaissance of American whiskey." Together they're approaching 1 million cases sold.

Also pushing sales higher was strength in the tequila category, with Herradura at 200,000 cases and el Jimador hitting 600,000 cases. Although perhaps not as well-known as some other competing brands from rival distillers, together with the bourbon brands they represent Brown-Forman's primary growth drivers.

Brown-Forman is also actively seeking out other brands that will be the levers it pulls in the future to capitalize on the premiumization trend that has swept across the spirits industry. Gentleman Jack, Jack Daniel's Single Barrel, and Jack Daniel's Tennessee Rye are growing nicely and building out a profitable niche for the Jack Daniel's brand.

Cultivating an international flavor

In Europe, Gentleman Jack and Woodford Reserve are leading the way, but the tariffs that were imposed on whiskey in retaliation for President Trump raising duties on steel and aluminum are providing near-term headwinds.

Brown-Forman says the tariffs make its strategy to expand sales of the brands further "complicated," but it will invest in both regardless, betting the long-term payoff will be worth it. Tariffs, though, lowered the distiller's underlying year-to-date net sales by 1%, and if they remain in place, the total cost would be about $125 million.

Profits also took a hit as Brown-Forman absorbed the tariffs' higher costs. Gross margins fell 190 basis points, with two-thirds of that the result of the distiller absorbing the higher costs for its customers. Even so, net income rose 19% to $227 million.

The impact of the tariffs is disproportionate for Brown-Forman because the nature of its business has changed over the years. President and CEO Lawson Whiting said that some 30 years ago, the distiller used to make almost all of its Jack Daniel's volumes here in the U.S.; it was about an 80% to 20% split. Today, the situation has largely reversed, and Brown-Forman generates more than 60% of its volumes in international markets and only 40% inside the U.S.

More importantly, in the last decade, 80% of the incremental growth experienced has come from international markets, and the growth is evenly divided between developed and emerging markets. Year to date, though, most of the growth is happening in emerging markets, with underlying sales jumping 10% but expanding only 4% in developed international markets and in the U.S., respectively.

A strong outlook regardless

Brown-Forman maintains underlying net sales should rise between 6% and 7% for the full year, with operating income rising 4% to 6%. It guided its outlook for earnings to be between $1.65 and $1.75 per share, the same as it offered last quarter.

Jack Daniel's remains the brand that holds Brown-Forman's center, and by introducing complementary extensions over the years such as Gentleman Jack, Tennessee Honey, and Tennessee Fire (the cinnamon-flavored whiskey) under the Jack Daniel's umbrella, Brown-Forman has been able to navigate the trade tensions now roiling the market.

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